Explosive Hyperinflation, Inflation-Tax Laffer Curve, and Modeling the Use of Money

Jesús Vázquez, Universidad del País Vasco
María-José Gutiérrez, Universidad del País Vasco

Abstract

This paper analyzes the existence of an inflation-tax Laffer curve (ITLC) in the context of two standard optimizing monetary models where agents' preferences are characterized by a constant relative risk aversion utility function. Explosive hyperinflation rules out the presence of an ITLC. In the context of a cash-in-advance economy, this paper shows that explosive hyperinflation is feasible and thus an ITLC is ruled out whenever the relative risk aversion parameter is greater than one. In a money-in-the-utility function model, it is shown that (i) an ITLC is also ruled out and (ii) explosive hyperinflations are more likely when the transactions role of money is more important.