Optimal taxation of bondholders

When the central bank drives the long-term interest rate below the growth rate by conducting an expansionary monetary policy, it taxes bondholders. Just as there is a level of inflation that maximises the inflation tax, there is an optimal differential between the growth rate and the long-term interest rate that maximises the amount of tax levied on bondholders. Indeed, w hen the long-term interest rate falls relative to the growth rate, the rate of tax on bondholders increases, but demand for bonds from investors/savers falls (the weighting of bonds in their wealth decreases), so the tax base decreases (equivalently, the central bank is forced to buy a larger quantity of bonds to reduce the quantity held by investors/savers). Above a certain tax rate (below a certain interest rate), the fall in the stock of bond holdings outweighs the increase in the tax rate. There is therefore a tax rate (a growth-interest rate differential) that maximises the tax on bondholders.