TAX EFFECTS, PRICE EXPECTATIONS AND THE NOMINAL RATE OF INTEREST

Abstract

This paper investigates the relationship between price expectations, income taxes and the nominal rate of interest in Canada. Our primary approach was to utilize the rational expectations hypothesis to create a synthetic price expectations series and to apply this series to four models of the determination of the nominal rate of interest; the Yohe-Karnovsky model, the Carr-Smith model, the Feldstein-Eckstein model and the Jenkins-Lim model. The analysis is inconclusive with respect to the Darby hypothesis that income tax considerations will cause the nominal rate of interest to increase by more than the increase in the expected rate of inflation.