Optimal fiscal and monetary policy in a cash-in-advance growing econom

The optimal fiscal and monetary policy is studied in a context of a cash-in-advance growing economy. There is no unique optimal combination of the income tax and the inflation tax since the steady-state welfare depends critically on the sum of revenues from the two taxes. In general, Friedman's (1969) optimum quantity of money rule can be a part of the optimal tax structure. Barro's (1988) optimality result concerning the optimal size of government in a barter economy is preserved in a monetary economy. However, Barro's (1988) optimal income tax rule is violated in countries that rely heavily on the inflation tax. Countries that earn a significant portion of their revenues via the inflation tax have to follow the optimal tax structure obtained in this dissertation. The empirical study is constructed to investigate the optimal size of government. The results from the empirical study can be used as a guide to judge whether or not the government acts optimally.