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This edition was written by Elijah Asdourian, Sam Boocker, Georgia Nabors, and David Wessel.
The Tax Cuts and Jobs Act (TCJA) of 2017 lowered corporate tax rates, altered investment incentives, and reformed the taxation of international income. Using administrative tax data and a general equilibrium model of tax policy and investment behavior, Gabriel Chodorow-Reich of Harvard and co-authors find that TCJA provisions produced a 20% increase in domestic investment for firms experiencing the average change in tax rate relative to those that saw no change in their taxes. The TCJA included incentives to expand holdings of tangible international capital, and U.S. multinationals increased foreign investment accordingly. Firms also reacted to these incentives by increasing their domestic investment, suggesting that foreign and domestic capital are complements in production. The authors estimate a long-run increase in domestic corporate capital of over 7%. Nonetheless, even after taking account of the increased tax revenues resulting from the boost to economic growth from more investment, the authors find that the TCJA still reduced revenues.
The extent to which government expenditure and debt is a driver of inflation, known as the “fiscal theory of the price level,” is a contested idea within modern macroeconomics. Examining the experience of 37 industrialized countries, Robert Barro of Harvard and Francesco Bianchi of Johns Hopkins find that the fiscal expansion in response to the COVID pandemic has been a contributing factor to recent inflation. Consistent with the theoretical predictions of the fiscal theory of the price level, Barro and Bianchi conclude that OECD governments were successfully able to generate inflation by increasing government expenditure following the COVID pandemic. In particular, the authors estimate that the reduction in the real value of debt as a result of unexpected inflation financed 40-50% of the cost of the COVID-related fiscal expansion.
“In the light of all of this, and with this I would like to conclude, disinflation really does seem like a long-distance race. When the runner enters the last mile, the hardest work begins. While the first phase of the race may have appeared easy, the last mile requires perseverance and vigilance. The same is true for our fight against inflation,” says Isabel Schnabel, member of the European Central Bank Executive Board.
“Perseverance is needed to avoid declaring victory too early. With our current monetary policy stance, we expect inflation to return to our target by 2025. The progress on inflation that we have seen so far is encouraging and in line with our projections. We therefore decided to leave our key policy rates unchanged at last week’s monetary policy meeting.”
“However, the disinflation process during the last mile will be more uncertain, slower and bumpier. Continued vigilance is therefore needed. After a long period of high inflation, inflation expectations are fragile and renewed supply-side shocks can destabilize them, threatening medium-term price stability. This also means that we cannot close the door to further rate hikes.”
The Brookings Institution, 1775 Massachusetts Ave NW, Washington,DC, 20036