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In this paper, I consider a dynamic economy in which a government needs to finance a stochastic process of purchases. The agents in the economy are privately informed about their skills, which evolve stochastically over time; I impose no restriction on the stochastic evolution of skills. I construct a tax system that implements a symmetric constrained Pareto optimal allocation. The tax system is constrained to be linear in an agent's wealth, but can be arbitrarily nonlinear in his current and past labor incomes. I find that wealth taxes in a given period depend on the individual's labor income in that period and previous ones. However, in any period, the expectation of an agent's wealth tax rate in the following period is zero. As well, the government never collects any net revenue from wealth taxes.

We consider an environment in which agents' skills are private information and follow arbitrary stochastic processes. We prove that it is typically Pareto optimal for an individual's marginal benefit of investing in capital to exceed his marginal cost of doing so. This wedge is consistent with a positive tax on capital income. We also prove that it is Pareto optimal for the marginal rate of substitution between any two consumption goods to equal the marginal rate of transformation. This lack of a wedge is consistent with uniform taxation of consumption goods within a period.

This paper examines the sets of feasible allocations in a large class of economic environments in which commitment is impossible (following Myerson [8], the standard definition of feasibility is adapted to take account of the lack of commitment). The environments feature either memory or money. Memory is defined as knowledge on the part of an agent of the full histories of all agents with whom he has had direct or indirect contact in the past. Money is defined as an object that does not enter utility or production functions, and is available in fixed supply. The main proposition is that any allocation that is feasible in an environment with money is also feasible in the same environment with memory. Depending on the environment, the converse may or may not be true. Hence, from a technological point of view, money is equivalent to a primitive form of memory. Journal of Economic Literature Classification Numbers: E40, C73, D82. 1998 Academic Press I. INTRODUCTION At its heart, economic thinking about fiat money is paradoxical. Fiat money consists of intrinsically useless objects that do not enter utility or production functions. But at the same time, these barren tokens allow societies to achieve allocations that would otherwise not be achievable. The purpose of this paper is to uncover what permits these barren tokens to article no. ET972357 232 0022-0531Â98 25.00

In this paper, I provide a possible explanation of why nominally risk-free bonds are essential in monetary economies. I argue that the role of nominal bonds is to enable agents to engage in intertemporal exchanges of money. I show that bonds can only serve this role if they are illiquid (costly to exchange for goods). Finally, I argue that in economies in which nominal bonds are essential, it is optimal for monetary policy to respond to changes in the distribution of liquidity needs.

In this paper, we consider an environment in which agents' skills are private information, are potentially multi-dimensional, and follow arbitrary stochastic processes. We allow for arbitrary incentivecompatible and physically feasible tax schemes. We prove that it is typically Pareto optimal to have positive capital taxes. As well, we prove that in any given period, it is Pareto optimal to tax consumption goods at a uniform rate. * Kocherlakota acknowledges the support of NSF SES-0076315. For comments and questions, email