Sub-Optimality of the Friedman Rule with Distorting Taxes
FEUNL Working Paper Series No. 623
28 Pages Posted: 20 Mar 2018
Date Written: February 2017
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.
Keywords: Friedman rule, fiscal policy, monetary policy, taxes, transfers, inflation
JEL Classification: E52, E62, E63
Suggested Citation: Suggested Citation