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Taxation, Credit Spreads and Liquidity Traps

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  • William John Tayler
  • Roy Zilberman

Abstract

We argue that optimal state-contingent variations in asset taxation increase welfare, alter the monetary policy transmission mechanism and insure against liquidity traps. These findings are explained by an endogenous relationship between taxation, the effective rate of return on assets, the inflationary output gap and credit spreads. Such unique link operates via a working-capital cost channel, and affords the policy maker an additional degree of freedom in stabilizing the economy. Optimal policy calls for lowering (increasing) asset taxation following adverse financial (demand) shocks. Severe financial contractions, nonetheless, warrant a more limited tax cut to minimize the occurrence of unintended liquidity traps induced by (otherwise optimal) large fiscal subsidies.

Suggested Citation

  • William John Tayler & Roy Zilberman, 2017. "Taxation, Credit Spreads and Liquidity Traps," Working Papers 173174116, Lancaster University Management School, Economics Department.
    • Handle: RePEc:lan:wpaper:173174116
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    More about this item

    Keywords

    Asset Taxation; Optimal Policy; Risk Premium; Credit Cost Channel; Zero Lower Bound;
    All these keywords.

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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