Inflation Aversion and the Optimal Inflation Tax

Gaowang Wang

and

Heng-fu Zou

The optimal inflation tax is reexamined in the framework of dynamic second best economy populated by individuals with inflation aversion. A simple
formula for the optimal inflation rate is derived. Different from the literature,
it is shown that if the marginal excess burden of other distorting taxes approaches zero, Friedman's rule for optimum quantity of money is not optimal, and the optimal inflation tax is negative; if the marginal excess burden of other taxes is nonzero, the optimal inflation rate is indeterminate and relies on the tradeoffs between the impatience effect of inflation and the effects of other economic forces in the monetary economy.