Optimal mix of monetary and fiscal policies in an innovation-driven economy

We construct an R&D-based growth model in which the government can reduce income taxes using seigniorage, that is, revenue from issuing new money. Using this model, we analytically derive the growth rate of the nominal money stock that maximizes welfare and show explicitly how the welfare-maximizing money growth rate depends on the parameters of the economy. In particular, the results show that stronger patent protection lowers the welfare-maximizing money growth rate. Therefore, lower inflation is preferred in countries with stronger patent protection. This theoretical result is consistent with the observed tendency for the inflation rates to be lower in developed countries, where patent protection is stronger than in developing countries.