Optimal Monetary Policy and Interest Income Taxation

Abstract

This paper studies optimal discretionary monetary policy when the basic new Keynesian model is extended to incorporate interest income taxation. The elasticities of ináation and the output gap to supply and demand shocks are increasing functions of the tax rate. Moreover, numerical simulations show that high levels of taxation increase ináation volatility, the output gap volatility and the unconditional expectation of the central bankís loss function.