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Inflation and the underground economy

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Author Info
Ahiabu, Stephen
Abstract

This paper studies the optimal rate of seigniorage in an economy characterized by bilateral trade and a tax-evading underground sector. Optimal inflation depends on which sector, formal or underground, is more congested with buyers. If the underground sector is more congested, the optimal inflation rate in Peru is about 42.69% per annum. This offers a possible motivation for the high rates of inflation observed in that country in the 1980s. A policy that returns this economy to Friedman rule delivers a welfare loss that is equivalent to a 14% drop in consumption for the representative household. If the formal sector is more congested however, optimal inflation falls to 1.48%, close to the rate observed in 2005.

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File URL: http://mpra.ub.uni-muenchen.de/1706/
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 763.

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Date of creation: Oct 2006
Date of revision: Nov 2006
Handle: RePEc:pra:mprapa:763

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Related research
Keywords: Inflation Market Congestion Ramsey Equilibrium Underground Economy

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Find related papers by JEL classification:
H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
E26 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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  5. repec:cup:macdyn:v:7:y:2003:i:3:p:333-62 is not listed on IDEAS
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  11. Ng, Yew-Kwang, 1980. "Optimal Corrective Taxes or Subsidies When Revenue Raising Imposes an Excess Burden," American Economic Review, American Economic Association, vol. 70(4), pages 744-51, September. [Downloadable!] (restricted)
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  13. 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. [Downloadable!] (restricted)
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    • S. Boragan Aruoba & Christopher J. Waller & Randall Wright, 2007. "Money and capital," Working Paper 0714, Federal Reserve Bank of Cleveland. [Downloadable!]
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  17. Brian Peterson & Shouyong Shi, 2006. "Money, Price Dispersion and Welfare," Working Papers tecipa-191, University of Toronto, Department of Economics. [Downloadable!]
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