Optimal Inflation with Corporate Taxation and Financial Constraints

Philippe Weil, Giovanni Lombardo, Caterina Mendicino and Daria Finocchiaro

No 10847, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: This paper revisits the equilibrium and welfare effects of long-run inflation in the presence of distortionary taxes and financial constraints. Expected inflation interacts with corporate taxation through the deductibility of i) capital expenditures at historical value and ii) interest payments on debt. Through the first channel, inflation increases firms? taxable profits and further distorts their investment decisions. Through the second, expected inflation affects the effective real interest rate negatively, relaxes firms? financial constraints and stimulates investment. We show that, in the presence of collateralized debt, the second effect dominates. Therefore, in contrast to earlier literature, we find that when the tax code creates an advantage of debt financing, a positive rate of long-run inflation is beneficial in terms of welfare as it mitigates the financial distortion and spurs capital accumulation.

Keywords: Credit frictions; Friedman rule; Optimal monetary policy; Tax benefits of debt (search for similar items in EconPapers)
JEL-codes: E31 E43 E44 E52 G32 (search for similar items in EconPapers)
Date: 2015-09
New Economics Papers: this item is included in nep-cba and nep-mac
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Optimal inflation with corporate taxation and financial constraints (2018)
Working Paper: Optimal Inflation with Corporate Taxation and Financial Constraints (2018)
Working Paper: Optimal Inflation with Corporate Taxation and Financial Constraints (2018)
Working Paper: Optimal Inflation with Corporate Taxation and Financial Constraints (2017)
Working Paper: Optimal inflation with corporate taxation and financial constraints (2015)
Working Paper: Optimal Inflation with Corporate Taxation and Financial Constraints (2015)
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