OPTIMAL GOVERNMENT FINANCIAL POLICY IN A TRANSACTIONS-COST MODEL OF MONEY (MONETARY POLICY, FISCAL POLICY, PUBLIC FINANCE)

This dissertation addresses the problem of finding optimal fiscal and monetary policies in a macroeconomic model with a microeconomic base. The main features of the theoretical model presented here are: (1) The government chooses from the full range of financing possibilities--taxes, bonds, and money; (2) Demands for money and bonds are explicitly modeled based on utility maximization by individuals in a model in which bonds pay a higher explicit rate of return than money, but the use of bonds entails transactions costs; (3) A public-finance approach is utilized in which costs and benefits are measured in social welfare terms.;The model of chapter 5 explicitly examines the choice between money and bonds in terms of transactions costs which are incurred when bonds are purchased or sold. The existence of transactions costs explains the coexistence of money and bonds when bonds pay a higher explicit return. Because of the complicated equilibrium conditions of the model, numerical examples are used to illustrate the results.;One of the major concerns about government debt is its effect on the capital stock. Chapter 6 introduces individual capital which is useful in increasing production. Maximizing social welfare is more complicated because the government must include in its calculations the welfare effects of the crowding-out of capital.;Pure public goods and proportional taxation are introduced in chapter 7. The government finds the optimal mix of finance by taxes, bonds, and money by examining the social-welfare costs of each method. Policy experiments are performed to look at the effects of nonoptimal policies.;Chapters 1 and 2 provide a brief overview of the theoretical and empirical literature on the effects of alternative methods of government finance. The basic theoretical model is developed in chapter 3. The model is an overlapping-generations model with two-period lived agents. A minimum size on bonds restricts some agents to use money rather than bonds as a store of value. The government is capable of using debt and money to make everyone better off--a situation described as an intergenerational free lunch. A neutrality theorem shows that any change in government debt and any change in the money supply may be neutral in their effects providing that the government adjusts lump-sum taxes appropriately. Extensions to this basic model are considered in chapter 4.