Journal of Monetary Economics2013-09-05 2:57 AM

Incentive-feasible deflation

Highlights • Friedman rule assumes a source of finance: lump-sum taxation. • Lump-sum taxes are like a debt obligation. • If people are permitted to default on debt (punishment is limited), then this places limits on public finance. • There may exist an incentive-based limit to deflation. Abstract For competitive economies in which the real rate of return on money is too low, the standard prescription is to engineer a deflation—that is, to operate monetary policy according to the Friedman rule. Implicit in this recommendation is the availability of a lump-sum tax instrument. In this paper, I view lump-sum tax obligations as a form of debt subject to default. While individuals may want to honor such obligations ex ante, a lack of commitment (the sine qua non of modern monetary theory) may prevent them from the following through on their promises ex post. When this is the case, there may exist an incentive-induced limit to deflationary policy.

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Journal of Monetary Economics

The Journal of Monetary Economics is a peer-reviewed academic journal covering research on macroeconomics and monetary economics. It is published by Elsevier and was established in October 1973 by Karl Brunner and Charles I. Plosser.

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