Deviating from the Friedman Rule: A Good Idea with Illegal Immigration?

This paper studies the optimal inflation rate in a transactions costs model with illegal immigration. Although unauthorized immigrants use domestic money for making transactions and consume in the host country, their welfare does not enter the objective function of the Ramsey planner, because of their unofficial status. In this environment, the Friedman rule is nonoptimal, when only an income tax is available, as the inflation tax makes it possible to collect revenues from illegal immigrants, who are difficult to subject to taxation. When a consumption tax –that illegal immigrants have to pay when buying consumption goods in the host country– is also available, the zero inflation tax prescription is efficient only if the consumption-money ratio of domestic consumers is not greater than the illegal immigrants’ one.