Journal Issue
Working Paper Summaries (WP/93/1 - WP/93/54)

Summary of WP/93/37: “Private Saving, Public Saving, and the Inflation Tax: Another Look at an Old Issue”

International Monetary Fund
Published Date:
August 1993
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The distortions caused by inflation on conventional national account aggregates have been widely discussed in the literature. Two aspects of the problem have received particular attention: monetary correction of interest payments on nonindexed debt instruments and the proper classification of the proceeds from the inflation tax in measures of the public sector deficit. This paper focuses on the second issue, analyzing the consequences of omitting the inflation tax from standard national account definitions. It uses the framework developed by Calvo (1986 and 1987), a model that has solid microeconomic foundations and is simple enough as an expos itional tool.

The model portrays a representative individual who maximizes his lifetime utility over an infinite horizon. The individual faces two types of taxes: a lump-sum tax and the inflation tax. It is shown that, in a steady state with a constant inflation rate, the optimal level of private consumption depends on the overall tax burden but not on the structure of the tax system--that is, on the relative importance of the inflation tax. This result implies that it is impossible to infer the effects on the economy of certain government policies exclusively on the basis of national accounts figures. Rather, it would be necessary to take into account the evolution of seigniorage collection by the government. In particular, the paper shows that standard national account definitions of private saving and the budget deficit create the illusion that heavier reliance on the inflation tax is associated with higher saving by the private sector when, in fact, private saving is unrelated to inflation in the model developed here. Using figures from Mexico and Uruguay, the paper shows that the inflation tax bias may represent a significant percentage of domestic saving.

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