Risk, Optimal Government Finance, and Monetary Policies in a Growing Economy.

Optimal tax and monetary policies in a stochastic monetary growth model are investigated. Our findings are of three general types. First, both capital income taxes and monetary growth are shown to influence the economy through effective risk adjusted measures, expressed as a linear function of their respective means and variances. Second, two stochastic netrality results relating to money and bonds, the two nominal assets in the economy, are identified. Third optimal policy rules relating to taxes, bond finance, and money creation are characterized. An essential component of optimal financial policy is a risk-adjusted balanced budget.