04 Long-run Impact of Inflation Tax on Non-oil Sectors in Iran’s Economy: Investigating Friedman and Phelps Rules Using long-run Structural Approach (SVECX)

The optimal inflation tax rate is very controversial. Many economists follow Friedman (1969) in regarding the focus on welfare costs of the inflation tax and conclude that the optimal level of the inflation tax is zero. In contrast, some economists follow Phelps (1973) in regarding claim that the inflation tax is a kind of tax and so according to the Ramsey rule it has a positive optimal rate. The present paper investigates the effect of inflation tax on agricultural, industrial, and services sectors using a structural vector error correction model with weakly exogenous variable (SVECX) during the period 1979-2012 (available data on capital in 2017). The findings indicate that the agricultural sector is not affected by inflationary finance policies, but inflation tax and financial repression lead to decrease output of the industry and services sectors. Then the negative impact of the inflation tax is confirmed in Iran’s economy. Based on the adverse effects of the inflation tax on the output growth, it can be concluded that, according to Friedman’s rule, the "zero rate" for the inflation tax should be considered as an optimal policy in the policymaking.