First draft: 14 Dec 2015. This version: 4 July, 2016.
Abstract
An overlapping generations model is set out in which monetary policy matters for distortionary taxes because unanticipated inflation has real wealth effects on households with nominal government debt. The model is used to study the tax burden under inflation and nominal GDP targeting. Nominal GDP targeting makes taxes less volatile than inflation targeting but raises average taxes. With a quadratic loss function, the expected tax burden is minimized with only indexed debt under inflation targeting, but with both indexed and nominal debt under nominal GDP targeting. Nominal GDP targeting lowers the tax burden relative to inflation targeting (except at very high indexation shares), but this conclusion hinges on risk aversion, productivity persistence and the loss function for the tax burden.
Michael Hatcher
Economics Department, University of Southampton
Email: M.C.Hatcher@soton.ac.uk.