Inflation and the underground economy
AbstractThis paper studies the optimal rate of seigniorage in an economy characterized by decentralized trade and a tax-evading underground sector. The economy has buyers, some of whom visit the formal market, while others visit the underground market. I find that the optimal rate of inflation depends on which of the two sectors, formal or underground, is more crowded/congested with buyers. If the underground sector is more crowded, the optimal inflation rate is as high as 42% per annum for Peru. That is, I offer a possible motivation for the high rates of inflation observed in that country from the mid 1970s up to the mid 1990s. If the formal sector is more crowded, optimal inflation falls to about 1.4%, which is close to the rate in 2005. Friedman rule is not optimal.
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Bibliographic InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 763.
Date of creation: Oct 2006
Date of revision: Oct 2006
Inflation; Market Congestion; Ramsey Equilibrium; Underground Economy;
Find related papers by JEL classification:
- E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
- E26 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Informal Economy; Underground Economy
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-11-12 (All new papers)
- NEP-CBA-2006-11-12 (Central Banking)
- NEP-MAC-2006-11-12 (Macroeconomics)
- NEP-MON-2006-11-12 (Monetary Economics)
- NEP-PBE-2006-11-12 (Public Economics)
- NEP-REG-2006-11-12 (Regulation)
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