The Optimal Quantity of Money Rule in the Theory of Public Finance

Abstract

This paper examines optimal tax policy in a monetary economy in which money serves as an intermediate good that helps facilitate the conversion of scarce resources into final consumption goods by enabling consumers to economize on the costs of transacting. It is shown that in such an environment, even though distorting taxes must be levied for revenue purposes, the optimal tax structure calls for abstaining from inflationary finance and adopting the optimum quantity of money rule.