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Sub-Optimality of the Friedman Rule with Distorting Taxes

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  • Bernardino Adão
  • André C. Silva

Abstract

We find that the Friedman rule is not optimal with government transfers and distortionary taxation. This result holds for heterogeneous agents, standard homogeneous preferences, and constant returns to scale production functions. The presence of transfers changes the standard optimal taxation result of uniform taxation. As transfers cannot be taxed, a positive nominal net interest rate is the indirect way to tax the additional income derived from transfers. The higher the transfers, the higher is the optimal inflation rate. We calibrate a model with transfers to the US economy and obtain optimal values for inflation substantially above the Friedman rule.

Suggested Citation

  • Bernardino Adão & André C. Silva, 2018. "Sub-Optimality of the Friedman Rule with Distorting Taxes," Working Papers w201803, Banco de Portugal, Economics and Research Department.
    • Handle: RePEc:ptu:wpaper:w201803
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    References listed on IDEAS

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    1. Bernardino Adao & Andre C. Silva, 2017. "Sub-optimality of the Friedman rule with distorting taxes," Nova SBE Working Paper Series wp623, Universidade Nova de Lisboa, Nova School of Business and Economics.

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    More about this item

    JEL classification:

    • 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
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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