https://macropaperwarehouse.com/authors/yang-liu/Yang LiuHugo -- gohugo.ioen-usThu, 01 Jan 2026 00:00:00 +0000https://macropaperwarehouse.com/papers/optimal-taxation-of-inflation/Thu, 01 Jan 2026 00:00:00 +0000https://macropaperwarehouse.com/papers/optimal-taxation-of-inflation/<p>This paper analyzes the effectiveness of a tax on inflation policy (TIP)—a fiscal instrument that would require firms to pay a tax proportional to the increase in their prices—as a complement to conventional monetary policy in a New Keynesian framework with multiple sources of inflation. The central result is that combining TIP with conventional monetary policy can implement the first-best allocation in which inflation is zero and the output gap is closed at all times under any path of shocks. Policy instruments should completely specialize: monetary policy should track the neutral rate of interest (addressing demand and productivity shocks by keeping output at its efficient level), while TIP should rise with markup and inflation expectation shocks. Unlike the 1970s view that saw TIP as a substitute for monetary policy, TIP is shown to be a complement. TIP corrects an externality in firms&rsquo; pricing decisions without exacerbating relative price distortions. Calibrated simulations suggest a reasonably calibrated TIP could lower the variance of inflation by 45% and of output by 44% relative to a Taylor-rule-only regime.</p>