Money Taxes and Efficiency When Sunspots Matter

This paper examines the impact monetary redistribution policies have on the amount of sunspot-induced volatility in an economy. A dynamic model of segmented asset markets is presented in which the tax-transfer policy determines, in a continuous way, the influence sunspots can have on the general price level and on consumption. If the policy leads to a transfer of resources across segmentation lines, there exist equilibria in which sunspots affect consumption. The primary result is that there is an efficiency cost of taxation: larger transfers lead to larger fluctuations in consumption. The paper also shows that, in many cases, improvements in asset markets that decrease consumption volatility simultaneously increase price-level volatility