The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money

Ritter, Moritz (2007): The Optimum Quantity of Money Revisited: Distortionary Taxation in a Search Model of Money.

Abstract

This paper incorporates a distortionary tax into the microfoundations of money framework and revisits the optimum quantity of money. An optimal policy may consist of both a positive tax rate and a positive nominal interest rate: if the buyer’s surplus share is inefficiently small, the intensive margin is distorted and the constrained optimal policy combines a sales tax with a money growth rate above that prescribed by the Friedman rule. Monetary, but not fiscal, policy alters the agent’s bargaining position, leaving a special role for a deviation from the Friedman rule. Under similar conditions, this conclusion carries over to competitive pricing.

• Item Type: MPRA Paper
• Institution: University of Toronto
• Language: English
• Keywords: Money; Search; Friedman Rule; Sales Tax
• Subjects: H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency ; Optimal Taxation; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E63 - Comparative or Joint Analysis of Fiscal and Monetary Policy ; Stabilization ; Treasury Policy; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy

References

Aruoba, Boragan S. and Sanjay K. Chugh, ”Optimal Fiscal and Monetary Policy when Money is Essential,” Working Paper, University of Maryland, 2006. Berentsen, Aleksander and Guillaume Rocheteau, ”On the Friedman Rule in Search Models of Money,” Contributions to Macroeconomics 3 (2003), 1-19. Berentsen, Aleksander, Guillaume Rocheteau and Shouyong Shi, ”Friedman Meets Hosios: Efficiency in Search Models of Money,” Economic Journal (2006), forthcoming. Chari, V.V., Lawrence Christiano and Patrick Kehoe, ”Optimality of the Friedman Rule in Economies with Distorting Taxes,” Journal of Monetary Economics (1996) 38, 203-233. Correia, Isabel and Petro Teles, ”Is the Friedman Rule Optimal When Money is and Intermediate Good?,” Journal of Monetary Economics 38 (1996), 223-244. Faig, Miquel, ”Characterization of the Optimal Tax on Money when it Functions as a Medium of Exchange,” Journal of Monetary Economics 22 (1988), 137-148. Friedman, Milton, ”The Optimum Quantity of Money,” in: Friedman, Milton, The Optimum Quantity of Money and Other Essays (Chicago: Aldine, 1969),1-50. Head, Allen and Alok Kumar, ”Price Dispersion, Inflation, and Welfare,” International Economic Review 46 (2005), 533-572. Hosios, Arthur J., ”On the Efficiency of Matching and Related Models of Search and Unemployment,” Review of Economic Studies 57 (1990), 279-298. Kimbrough Kent P., ”The Optimum Quantity of Money Rule in the Theory of Public Finance,” Journal of Monetary Economics 18 (1986), 277-284. Kocherlakota, Narayana, ”Money is Memory,” Journal of Economic Theory 81 (1998), 232-259. Lagos, Ricardo and Randall Wright, ”A unified framework for monetary theory and policy analysis,” Journal of Political Economy 113 (2005), 463—484. Li, Victor, ”The Optimal Taxation of Fiat Money in Search Equilibrium,” International Economic Review 36 (1995), 927-942. Mortensen, Dale and Christopher Pissarides, ”Job Creation and Job Destruction in the Theory of Unemployment,” Review of Economic Studies 61 (1994), 397-415. Muthoo, Abhinay, Bargaining Theory with Applications, (Cambridge: Cambridge University Press, 1999). Phelps, Edward, ”Inflation in the Theory of Public Finance,” Swedish Journal of Economics 75 (1973), 67-82. Rocheteau, Guillaume and Randall Wright, ”Money in Search Equilibrium, in Competitive Equilibrium, and in Competitive Search,” Econometrica 73 (2005), 175-202. Shi, Shouyong, ”A Divisible Model of Fiat Money,” Econometrica 65 (1997), 75-102. Shi, Shouyong, ”Search for a Monetary Propagation Mechanism,” Journal of Economic Theory 81 (1998), 314-352. Shi, Shouyong, ”Search, Inflation and Capital Accumulation,” Journal of Monetary Economics 44 (1999), 81-103.