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Inflation and the underground economy

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Author Info
Ahiabu, Stephen

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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;

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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References listed on IDEAS
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    Other versions:
  7. Thomas F. Cooley & Gary D. Hansen, 1991. "The welfare costs of moderate inflations," Proceedings, Federal Reserve Bank of Cleveland, pages 483-518.
    Other versions:
  8. repec:cup:macdyn:v:7:y:2003:i:3:p:333-62 is not listed on IDEAS
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    Other versions:
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  16. 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)
  17. Friedrich Schneider & Dominik H. Enste, 2000. "Shadow Economies: Size, Causes, and Consequences," Journal of Economic Literature, American Economic Association, vol. 38(1), pages 77-114, March. [Downloadable!] (restricted)
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    Other versions:
    • 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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    Other versions:
  20. Brian Peterson & Shouyong Shi, 2006. "Money, Price Dispersion and Welfare," Working Papers tecipa-191, University of Toronto, Department of Economics. [Downloadable!]
    Other versions:
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