On the use of the inflation tax when nondistortionary taxes are available

Using a pure-exchange overlapping generations model in which money is valued because of a legal restriction, we show the following: (a) a benevolent government may make some use of the inflation tax in conjunction with a lump-sum tax on the young but not if lump-sum taxes on the old are available, and (b) the welfare-maximizing monetary policy may deviate from the Friedman rule (contract the money supply so as to equate the real return on money and other competing stores of value) in either case. Journal of Economic Literature Classification Numbers: E58, E63, H21. (C) 2001 Academic Press.