Monetary policy and redistribution: What can or cannot be neutralized with Mirrleesian taxes

This paper develops an overlapping-generations model with heterogeneous agents in terms of earning ability and cash-in-advance constraint. It shows that tax pol- icy cannot fully replicate or neutralize the redistributive implications of monetary policy. While who gets the extra money becomes irrelevant, the rate of growth of money supply keeps its bite. A second lesson is that the Friedman rule is not in general optimal. The results are due to the existence of another source of het- erogeneity among individuals besides dierences in earning ability that underlies the Mirrleesian approach to optimal taxation. They hold even in the presence of a general income tax and preferences that are separable in labor supply and goods. If dierences in earning ability were the only source of heterogeneity, the scal au- thority would be able to neutralize the eects of a change in the rate of monetary growth and a version of the Friedman rule becomes optimal.