Finance and Economics Discussion Series (FEDS)
November 2002
Taxation and the Taylor Principle
Rochelle M. Edge and Jeremy B. Rudd
Abstract:
We add a nominal tax system to a sticky-price monetary business cycle model. When nominal interest income is taxed, the coefficient on inflation in a Taylor-type monetary policy rule must be significantly larger than one in order for the model economy to have a determinate rational expectations equilibrium. When depreciation is treated as a charge against taxable income, an even larger weight on inflation is required in the Taylor rule in order to obtain a determinate and stable equilibrium. These results have obvious implications for assessing the historical conduct of monetary policy.
Keywords: Taylor rule, Taylor principle, equilibrium determinacy
PDF: Full Paper
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