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A Fiscal Framework for Analysis of Interest Rate Behavior in Open Economies

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  • John H. Makin

Abstract

This paper derives a reduced-form expression for an interestrate in an open economy by incorporating after tax covered interest parity conditions into a simple neo-classical macro model. The result clearly demonstrates that the relationship between an interest rate and variables used to explain it is conditional on income tax rates at home and abroad and presence or absence of capital gains tax treatment of foreign exchange gains or losses. Effects of non-indexation of tax treatment of depreciation and inventories may also play a role. Any change in effective tax rates over a sample period employed to estimate interest rate (or exchange rate) equations may cause deterioration in the fit of a fixed coefficient model. Efforts are underway to employ a random coefficients approach to address this problem.

Suggested Citation

  • John H. Makin, 1984. "A Fiscal Framework for Analysis of Interest Rate Behavior in Open Economies," NBER Working Papers 1355, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:1355
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    References listed on IDEAS

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    1. Cukierman, Alex & Wachtel, Paul, 1982. "Relative Price Variability and Nonuniform Inflationary Expectations," Journal of Political Economy, University of Chicago Press, vol. 90(1), pages 146-157, February.
    2. Makin, John H, 1978. "Anticipated Inflation and Interest Rates in an Open Economy," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 10(3), pages 275-289, August.
    3. Carr, Jack L & Pesando, James E & Smith, Lawrence B, 1976. "Tax Effects, Price Expectations and the Nominal Rate of Interest," Economic Inquiry, Western Economic Association International, vol. 14(2), pages 259-269, June.
    4. Blinder, Alan S. & Fischer, Stanley, 1981. "Inventories, rational expectations, and the business cycle," Journal of Monetary Economics, Elsevier, vol. 8(3), pages 277-304.
    5. Martin Feldstein, 1983. "Inflation, Income Taxes, and the Rate of Interest: A Theoretical Analysis," NBER Chapters, in: Inflation, Tax Rules, and Capital Formation, pages 28-43, National Bureau of Economic Research, Inc.
    6. Darby, Michael R, 1975. "The Financial and Tax Effects of Monetary Policy on Interest Rates," Economic Inquiry, Western Economic Association International, vol. 13(2), pages 266-276, June.
    7. Levi, Maurice D, 1977. "Taxation and "Abnormal" International Capital Flows," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 635-646, June.
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    Cited by:

    1. Takatoshi Ito, 1983. "Capital Controls and Covered Interest Parity," NBER Working Papers 1187, National Bureau of Economic Research, Inc.

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