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Optimal Inflation with Corporate Taxation and Financial Constraints

Daria Finocchiaro (), Giovanni Lombardo (), Caterina Mendicino () and Philippe Weil ()

No ECARES 2017-50, Working Papers ECARES from ULB -- Universite Libre de Bruxelles

Abstract: How does inflation affect the investment decisions of financially constrained firms in the presence of corporate taxation? Inflation interacts with corporate taxation via the deductibility of i) capital expenditures 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 and stimulates investment. When debt is collateralized, the second effect dominates. Therefore, present a tax-advantage to debt financing, positive long-run inflation enhances welfare by mitigating or even eliminating the investment distortion.

Keywords: optimal monetary policy; Friedman rule; credit frictions; tax benefits of debt (search for similar items in EconPapers)
JEL-codes: E31 E43 E44 E52 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn, nep-mac and nep-mon
Date: 2017-12
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Related works:
Journal Article: Optimal inflation with corporate taxation and financial constraints (2018) Downloads
Working Paper: Optimal inflation with corporate taxation and financial constraints (2015) Downloads
Working Paper: Optimal Inflation with Corporate Taxation and Financial Constraints (2015) Downloads
Working Paper: Optimal Inflation with Corporate Taxation and Financial Constraints (2015) Downloads
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