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Optimal taxation and debt composition: Is Monetary Policy Too Costly?

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  • Gerardo Licandro

    (Banco Central del Uruguay)

Abstract

Using an optimal taxation model, in which inflation and inflation variability are tied together, we are able to determine that the incentives to generate inflationary surprise backfire, increasing the cost of debt. When we require plans to be time consistent, we find that, although the policymaker would rather set inflation to international standards, this target is not part of any time consistent equilibrium. In order to achieve the Pareto-improving zero-inflation outcome the government needs to resort to commitment mechanisms. It is shown that an optimal selection of the debt-portfolio results in better outcomes by reducing the base of the inflation tax, but some inflationary bias persists as long as the national currency exists. With a debt portfolio in which nominal debt is incorporated, in order to achieve the zero-inflation Stackelberg equilibrium the country needs to commit to zero inflation.

Suggested Citation

  • Gerardo Licandro, 2000. "Optimal taxation and debt composition: Is Monetary Policy Too Costly?," Documentos de trabajo 2000007, Banco Central del Uruguay.
    • Handle: RePEc:bku:doctra:2000007
    as

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    File URL: https://www.bcu.gub.uy/Estadisticas-e-Indicadores/Documentos%20de%20Trabajo/7.2000.pdf
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    References listed on IDEAS

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    2. Gerardo Licandro, 2000. "Is Mercosur an Optimal Currency Area? A shock correlation perspective," Documentos de trabajo 2000004, Banco Central del Uruguay.
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    5. repec:bla:jecsur:v:11:y:1997:i:3:p:235-65 is not listed on IDEAS
    6. Grier, Kevin B. & Perry, Mark J., 1996. "Inflation, inflation uncertainty, and relative price dispersion: Evidence from bivariate GARCH-M models," Journal of Monetary Economics, Elsevier, vol. 38(2), pages 391-405, October.
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