Interest on Cash with Endogenous Fiscal Policy

Authors

Alexei Deviatov, New Economic School, Moscow
Neil Wallace, Pennsylvania State University

Abstract

Monetary policy and the welfare cost of inflation cannot be studied without some specification of allowable fiscal instruments. Here, feasible policies are implied by the frictions imposed to get roles for money and credit. The model has extreme versions of an above-ground economy and a benign underground economy. The former consists of people who are perfectly monitored and who, therefore, can be taxed; while the latter consists of people who are anonymous and, who, therefore, cannot be taxed. For various examples, ex ante (representative-agent) optima are computed. For most examples for the outside-money version of the model, it is not optimal to use taxes to raise the return on money held by anonymous people.