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This paper analyzes the effectiveness of a tax on inflation policy
(TIP), which would require firms to pay a tax proportional to the increase
in their prices or wages, in stabilizing inflation. We show that
TIP would effectively correct externalities in firms’ pricing decisions,
tackle excessive inflation and reduce output volatility. While proposals
from the 1970s saw TIP as a substitute to MP, we find that they
are complementary, with TIP addressing cost-push shocks, and MP
addressing demand shocks. In sharp contrast with price controls, TIP
doesn’t exacerbate relative price distortions.
