The Role of Inflationary Finance with Distortionary Taxes

This paper examines the role of inflationary finance together with the presence of distortionary taxes as a welfare-maximizing policy package. I derive an overlappinggeneration model with a linear production function and a fixed required reserve ratio for the model economy under various scenarios. The results illustrate that unless the distortionary tax system is not well-formulated, inflation tax is undesirable with other distortionary t axes. The computation also found that i ncome tax and inflation t ax are almost perfect substitutes to each other. Furthermore, three comparative static studies are carried out that show, ceteris paribus; government purchases and reserve requirement are negatively correlated with optimal inflation rate, whereas productivity is positively correlated with optimal inflation rate.