On the Complementarity of Commercial Policy, Capital Controls and Inflation Tax
This paper studies the optimal use of distortive policies aimed at raising a given real revenue, in a general equilibrium framework in which lump-sum taxes are absent. The policies analyzed are an inflation tax, commercial policy, and an implicit tax on capital inflows implemented by capital controls. It is shown that we would tend to avoid activating an inflation tax for small revenue needs. Furthermore, if the policy target were allocative, we would tend to use only one policy instrument. Thus, each policy has its own comparative advantage, and their combined use is justified when the target is raising government revenue. As a by-product of the paper, we study the determinants of exchange rates, prices, and quantities in an economy subject to capital controls and commercial policy.
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