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Optimal Inflation Tax And Structural Reform

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Author Info

  • de V. Cavalcanti, Tiago V.
  • Villamil, Anne P.

Abstract

This paper analyzes the optimal inflation tax in economies with structural imperfections in labor, commodity, and currency markets. The Friedman rule is a classic result in economics that claims that the optimal monetary policy is to set a zero nominal interest rate. This Ramsey equilibrium is robust in a wide range of environments without imperfections in input, output, or financial markets. In many developing countries, however, a large fraction of activity takes place in the informal sector. Roughly speaking, the informal sector is the untaxed and unregulated market sometimes referred to as the underground economy. We obtain three results. First, we show that when structural imperfections such as an informal sector exist, the optimal inflation tax is positive. Second, we show that structural imperfections introduce an important asymmetry in the welfare cost function. Third, we provide quantitative results.

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Bibliographic Info

Article provided by Cambridge University Press in its journal Macroeconomic Dynamics.

Volume (Year): 7 (2003)
Issue (Month): 03 (June)
Pages: 333-362

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Handle: RePEc:cup:macdyn:v:7:y:2003:i:03:p:333-362_02

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Cited by:
  1. Nicoletta Batini & Young-Bae Kim & Paul Levine & Emanuela Lotti, 2009. "Informal Labour and Credit Markets: A Survey," School of Economics Discussion Papers 0609, School of Economics, University of Surrey.
  2. Antunes, Antonio R. & Cavalcanti, Tiago V. de V., 2007. "Start up costs, limited enforcement, and the hidden economy," European Economic Review, Elsevier, vol. 51(1), pages 203-224, January.
  3. Samuel Gil Martín, 2012. "Liquidity, Welfare and Distribution," Panoeconomicus, Savez ekonomista Vojvodine, Novi Sad, Serbia, vol. 59(2), pages 217-234, May.
  4. Stanley Black & Charis Christofides & Alex Mourmouras, 2006. "Convertibility risk: the precautionary demand for foreign currency in a crisis," Annals of Finance, Springer, vol. 2(2), pages 141-165, March.
  5. Dibooglu, Sel & Kenc, Turalay, 2009. "Welfare cost of inflation in a stochastic balanced growth model," Economic Modelling, Elsevier, vol. 26(3), pages 650-658, May.
  6. Kodila-Tedika, Oasis & Mutascu, Mihai, 2013. "Shadow economy and tax revenue in Africa," MPRA Paper 50812, University Library of Munich, Germany.
  7. Alexandre Cunha, 2008. "The optimality of the Friedman rule when some distorting taxes are exogenous," Economic Theory, Springer, vol. 35(2), pages 267-291, May.
  8. Ahiabu, Stephen, 2006. "Inflation and the underground economy," MPRA Paper 763, University Library of Munich, Germany, revised Oct 2006.
  9. Pinar Yesin, 2004. "Tax Collection Costs, Tax Evasion and Optimal Interest Rates," Working Papers 04.02, Swiss National Bank, Study Center Gerzensee.
  10. Arbex, Marcelo & Turdaliev, Nurlan, 2011. "Optimal monetary and audit policy with imperfect taxation," Journal of Macroeconomics, Elsevier, vol. 33(2), pages 327-340, June.
  11. Stacey L. Schreft & Bruce D. Smith, 2003. "The social value of risk-free government debt," Research Working Paper RWP 03-02, Federal Reserve Bank of Kansas City.
  12. Robert R. Reed & Stacey L. Schreft, 2007. "Phillips curves, monetary policy, and a labor market transmission mechanism," Research Working Paper RWP 07-12, Federal Reserve Bank of Kansas City.
  13. Pinar Ayse Yesin, 2006. "Financing Government Expenditures Optimally," Working Papers 06.01, Swiss National Bank, Study Center Gerzensee.
  14. Alexandre Cunha, 2004. "The Friedman Rule in a Two Sector Small Open Economy," Econometric Society 2004 North American Summer Meetings 530, Econometric Society.
  15. Koreshkova, Tatyana A., 2006. "A quantitative analysis of inflation as a tax on the underground economy," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 773-796, May.

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