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Finance and Economics Discussion Series
Finance and Economics Discussion Series logo links to FEDS home page 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

Full paper (373 KB PDF)

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Last update: November 8, 2002