Sub-Optimality of the Friedman Rule with Distorting Taxes

FEUNL Working Paper Series No. 623

28 Pages Posted: 20 Mar 2018

See all articles by Bernardino Adao

Bernardino Adao

Bank of Portugal - Research Department

Andre C. Silva

Nova School of Business and Economics

Date Written: February 2017

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.

Keywords: Friedman rule, fiscal policy, monetary policy, taxes, transfers, inflation

JEL Classification: E52, E62, E63

Suggested Citation

Adao, Bernardino and Silva, Andre C., Sub-Optimality of the Friedman Rule with Distorting Taxes (February 2017). FEUNL Working Paper Series No. 623, Available at SSRN: https://ssrn.com/abstract=3141990 or http://dx.doi.org/10.2139/ssrn.3141990

Bernardino Adao

Bank of Portugal - Research Department ( email )

Av. Almirante Reis 71, 6th
Lisbon 1150-012
Portugal

Andre C. Silva (Contact Author)

Nova School of Business and Economics ( email )

Campus de Carcavelos
Carcavelos, 2775-405
Portugal

HOME PAGE: http://sites.google.com/view/andredecastrosilva

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