Working Paper: NBER ID: w1375
Authors: Carl E. Walsh
Abstract: Reserve requirements imposed against bank deposits, nominal interest payments on bank reserves (or on base money), and inflation can all be viewed as generating tax effects. Any analysis of optimal monetary policy in a steady-state equilibrium needs to consider the simultaneous choice of all the tax instruments controlled by the monetary authority. Such an analysis is carried out in this paper. It is shown that when the tax system is not indexed, the optimal nominal interest rate on the monetary authority's liabilities is likely to be zero. More importantly, any discussion of the payment of interest on reserves and currency must take into account the nature of the tax system and the rate of inflation in a nonindexed economy.
Keywords: Optimal Taxation; Monetary Policy; Inflation; Interest Rates
JEL Codes: E52; E58; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher rates of inflation (E31) | real money balances (E41) |
| inflation (E31) | tax on liquidity (F38) |
| optimal nominal interest rate on liabilities may be zero (E43) | non-indexed tax system (H20) |
| monetary authority can influence policy instruments (E52) | choice of inflation rate, reserve requirement ratio, and interest rate on reserves must be jointly determined (E52) |
| payment of nominal interest on money (E49) | not a perfect substitute for steady-state rate of deflation (E31) |
| nominal interest rates (E43) | inflation (E31) |
| inflation (E31) | effective tax rate on capital (F38) |