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TAX RULES TO PREVENT EXPECTATIONS-DRIVEN LIQUIDITY TRAPS

Published online by Cambridge University Press:  25 January 2021

Yoichiro Tamanyu
Yoichiro Tamanyu*
Affiliation:
Keio University
*
Address correspondence to: Yoichiro Tamanyu, 2-15-45 Mita, Minato-ku, Tokyo108-8345, Japan; E-mail: yoichiro.tamanyu@keio.jp
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Abstract

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Multiple equilibria arise in standard New Keynesian models when the nominal interest rate is set according to the Taylor rule and constrained by a zero lower bound (ZLB). One of these equilibria is deflationary and referred to as an expectations-driven liquidity trap (ELT) as it arises because of the de-anchoring of inflation expectations. This study demonstrates that a simple tax rule responding to inflation can prevent a liquidity trap from arising without increasing government spending or debt. We analytically investigate the necessary and sufficient conditions to prevent an ELT and show that both the frequency and persistence of ELT episodes affect the extent to which the tax rule must respond to inflation. In brief, the higher the frequency or the longer the persistence of the ELT, the greater the response of the tax rate must be.

Keywords

Expectations-Driven Liquidity TrapFiscal PolicyMonetary PolicyRegime SwitchingZero Lower Bound
Type
Articles
Information
Macroeconomic Dynamics , Volume 26 , Issue 6 , September 2022 , pp. 1564 - 1587
Creative Commons
Creative Common License - CCCreative Common License - BYCreative Common License - NCCreative Common License - ND
This is an Open Access article, distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives licence (https://creativecommons.org/licenses/by-nc-nd/4.0/), which permits non-commercial re-use, distribution, and reproduction in any medium, provided the original work is unaltered and is properly cited. The written permission of Cambridge University Press must be obtained for commercial re-use or in order to create a derivative work.
Copyright
© Cambridge University Press 2021

Footnotes

The author would like to thank the associate editor, two anonymous referees, as well as Anton Braun, Fumio Hayashi, Yasuo Hirose, Daisuke Ikeda, Taisuke Nakata, and Francesco Zanetti for their helpful comments. The author acknowledges the financial support of the Keio Economic Society for the provision of English language editing. The views expressed in this paper are those of the author and do not necessarily reflect those of any affiliated institution.

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