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: Suggested Citation