Taxation, Inflation, and Monetary Policy

Given that application of the principle with full loss offset to all assets is impracticable, we may wish to consider provision of only a partial inflation-exclusion to assets for which it is feasible. The problem is examined in this paper by means of a simple model of anticipated inflation, in which individuals may invest either in assets for which full or partial inflation-exclusion is provided, or in cash, for which no loss offset is allowed. Among other issues, we shall examine the short and long run effects of taxation and of the provision of an inflation deduction on the rate of inflation and on the level of savings. We do not discuss the long-run optimum tax and deduction rates, because it turns out that for a given tax revenue, these instruments are perfect substitutes, i.e. their relative size does not affect the equilibrium configuration.