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Optimal Fiscal and Monetary Policy with Distorting Taxes

Author

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  • Christopher A. Sims

Abstract

When government debt pays a lower return than private assets, the reasoning in Friedman's (1969) essay on the optimal quantity of money suggests that it would be optimal to expand the debt until its return matched that on private assets. When the only other source of revenue is a distorting tax, however, this is not generally true. In a perfect foresight model, a benevolent government that can make credible commitments chooses a large gap in returns initially and high distorting taxation in the distant future. The optimal path of taxation is time inconsistent, with ever-increasing temptation to abandon the path.

Suggested Citation

  • Christopher A. Sims, 2025. "Optimal Fiscal and Monetary Policy with Distorting Taxes," American Economic Journal: Macroeconomics, American Economic Association, vol. 17(2), pages 1-23, April.
    • Handle: RePEc:aea:aejmac:v:17:y:2025:i:2:p:1-23
    DOI: 10.1257/mac.20220245
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    More about this item

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H61 - Public Economics - - National Budget, Deficit, and Debt - - - Budget; Budget Systems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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