Inflation and the underground economy

Stephen Ahiabu ()

MPRA Paper from University Library of Munich, Germany

Abstract: This paper studies the optimal rate of seigniorage in an economy characterized by decentralized trade and a tax-evading underground sector. The economy has buyers, some of whom visit the formal market, while others visit the underground market. I find that the optimal rate of inflation depends on which of the two sectors, formal or underground, is more crowded/congested with buyers. If the underground sector is more crowded, the optimal inflation rate is as high as 42% per annum for Peru. That is, I offer a possible motivation for the high rates of inflation observed in that country from the mid 1970s up to the mid 1990s. If the formal sector is more crowded, optimal inflation falls to about 1.4%, which is close to the rate in 2005. Friedman rule is not optimal.

Keywords: Inflation; Market Congestion; Ramsey Equilibrium; Underground Economy (search for similar items in EconPapers)
JEL-codes: E26 E6 H21 (search for similar items in EconPapers)
Date: 2006-10, Revised 2006-10
New Economics Papers: this item is included in nep-cba, nep-mac, nep-mon, nep-pbe and nep-reg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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https://mpra.ub.uni-muenchen.de/1706/1/MPRA_paper_1706.pdf revised version (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:pra:mprapa:763

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