Paper #229

Title:

The optimum quantity of money: Theory and evidence

Authors:

Casey B. Mulligan and Xavier Sala-i-Martin

Date:

June 1997

Abstract:

In this paper we propose a simple and general model for computing the Ramsey optimal inflation tax, which includes several models from the previous literature as special cases. We show that it cannot be claimed that the Friedman rule is always optimal (or always non--optimal) on theoretical grounds. The Friedman rule is optimal or not, depending on conditions related to the shape of various relevant functions. One contribution of this paper is to relate these conditions to {\it measurable} variables such as the interest rate or the consumption elasticity of money demand. We find that it tends to be optimal to tax money when there are economies of scale in the demand for money (the scale elasticity is smaller than one) and/or when money is required for the payment of consumption or wage taxes. We find that it tends to be optimal to tax money more heavily when the interest elasticity of money demand is small. We present empirical evidence on the parameters that determine the optimal inflation tax. Calibrating the model to a variety of empirical studies yields a optimal nominal interest rate of less than 1\%/year, although that finding is sensitive to the calibration.

Keywords:

Optimal monetary policy, inflation tax

JEL codes:

E52, E61, E63

Area of Research:

Statistics, Econometrics and Quantitative Methods

Published in:

Journal of Money Credit and Banking, (1997)

Download the paper in PDF format