Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/128029
Authors: 
Yesin, Pinar
Year of Publication: 
2004
Series/Report no.: 
Working Paper, Study Center Gerzensee 04.02
Abstract: 
In this paper, I investigate to what extent the cross-country variation in nominal interest rates can be explained as being due to governments' optimal response to economic conditions such as tax collection costs, tax evasion and government consumption needs. In particular, I study the effects of costly income taxes in the presence of an informal sector on the solution to a Ramsey problem in a general equilibrium framework. Unlike most of the previous analyses of optimal inflationary finance, the model postulates that conventional taxes carry collection costs whereas flat money can be printed costlessly. For some countries, I measure tax collection costs, use the tax eva- sion estimates reported in the literature, and then calculate the optimal interest rate based on the model. Comparison of the actual and optimal interest rates demonstrates that the model can in fact partly explain the observed deviations from the Friedman Rule. I also show that allowing cross-country differences in the elasticity of substitution between formal and informal sectors can increase the model's explanatory power.
Subjects: 
Optimal Interest Rates
Tax Collection Costs
Tax Evasion
Friedman Rule
JEL: 
E31
H21
H26
O17
Document Type: 
Working Paper

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