Financing Government Expenditures Optimally

Study Center Gerzensee Working Paper No. 06.01

36 Pages Posted: 13 Sep 2006

Date Written: March 2006


In a simple cash-credit model, I study the effects of the combination of costly tax collection and tax evasion on fiscal and monetary policy for optimal resource allocation. Allowing the informal sector to use cash more intensively than the formal sector, I compute the optimal interest and tax rates for eleven OECD countries to finance their exogeneously given government spending. A comparison of the actual and optimal interest rates reveals that tax collection costs and tax evasion together can partly explain the cross-country differences in monetary policy, also rationalizing deviations from the Friedman Rule in the long-run.

Keywords: Optimal Interest Rates, Tax Collection Costs, Tax Evasion, Friedman Rule, Cash-intensive Informal Sector, Inflationary Finance

JEL Classification: E63, H21, H26

Suggested Citation

Yeşin, Pınar, Financing Government Expenditures Optimally (March 2006). Study Center Gerzensee Working Paper No. 06.01, Available at SSRN: or

Pınar Yeşin (Contact Author)

Swiss National Bank ( email )

Boersenstrasse 15, P.O.Box
Zurich, CH-8022
41-58-631-3969 (Phone)


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