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

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. ∗I am thankful to Shouyong Shi for his support and guidance. This paper has benefited from comments by and discussions with Andres Erosa and Miquel Faig. I also received valuable comments from seminar participants at the University of Toronto. All remaining errors and shortcomings are my own