Popular models of new Keynesian macroeconomics predict that reductions in various forms of indirect taxation are reduced when monetary policy is pegged to the lower zero. We turn to a longer period of history in the United Kingdom to test this idea. Using a new long-term data set of tax reform indexed by narratives from 1918 to 2020, we show that tax cuts increase in both low interest rate and normal periods. We also find no evidence of an increase in inflation in response to inflation or real rates in the ZLB, suggesting a limited role for the medium-term exchange rate. We highlight several other methods that may help correct our findings. Our results suggest that tax cuts may still be a useful tool to stimulate economic activity in times of tight monetary policy.
That appears in a recent paper by James Cloyne, Nicholas Dimsdale, and Patrick Hürtgen, forthcoming in JPE.
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