Monetary Policy and Redistribution: What Can or Cannot Be Neutralized with Mirrleesian Taxes

40 Pages Posted: 26 Jan 2012

See all articles by Firouz Gahvari

Firouz Gahvari

University of Illinois at Urbana-Champaign - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Luca Micheletto

University of Milan

Date Written: January 26, 2012

Abstract

This paper develops an overlapping-generations model with heterogeneous agents in terms of earning ability and cash-in-advance constraint. It shows that tax policy cannot fully replicate or neutralize the redistributive implications of monetary policy. While who gets the extra money becomes irrelevant, the rate of growth of money supply keeps its bite. A second lesson is that the Friedman rule is not in general optimal. The results are due to the existence of another source of heterogeneity among individuals besides differences in earning ability that underlies the Mirrleesian approach to optimal taxation. They hold even in the presence of a general income tax and preferences that are separable in labor supply and goods. If differences in earning ability were the only source of heterogeneity, the fiscal authority would be able to neutralize the effects of a change in the rate of monetary growth and a version of the Friedman rule becomes optimal.

Keywords: monetary policy, fiscal policy, redistribution, Friedman rule, heterogeneity, overlapping generations, second best

JEL Classification: H210, E520

Suggested Citation

Gahvari, Firouz and Micheletto, Luca, Monetary Policy and Redistribution: What Can or Cannot Be Neutralized with Mirrleesian Taxes (January 26, 2012). CESifo Working Paper Series No. 3711, Available at SSRN: https://ssrn.com/abstract=1992329

Firouz Gahvari (Contact Author)

University of Illinois at Urbana-Champaign - Department of Economics ( email )

313 David Kinley Hall, 1407 West Gregory Drive
Urbana, IL 61801
United States

HOME PAGE: http://www.economics.illinois.edu/people/fgahvari

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschingerstr. 5
Munich, DE-81679
Germany

Luca Micheletto

University of Milan ( email )

Via Festa del Perdono, 7
Milan, 20122
Italy

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