16 Sep 2022


Zero Inflation and Tax Incentives

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Macroeconomics came about during the depression in the United States in the 1970s and 1980s. This was a period that demanded change to the way people thought about the economy. Macroeconomics changed the scope of the economy from being an individual issue concerning certain businesses and their delivery to consumers to a nationwide and regional view of how unemployment, national output, and inflation or deflation affect the economy (Singh, 2014). Throughout the years these has been the goal of many economies in the world and has been key in the success of globalization in the world today.

Needless to say, macroeconomics and its opposite, microeconomics, are interdependent. issues that affect macroeconomics at the top also end up affecting microeconomics at the grass root level. For instance, inflation in macroeconomics affects microeconomic businesses as they have to increase their prices and also increase wages in order to meet their consumers’ needs and satisfy their employees (Zheng & Warner, 2010). The vice versa is also true. None of these sections can exist solely on its own.

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Economics has no constants. Every aspect varies based on human needs and wants. Therefore, macroeconomics has to be tightly regulated to prevent depression and result in more employment to the people. Two main methods are therefore used to regulate macroeconomic variables for the best outcome; fiscal policy and monetary policy. Monetary policy involves the control of money in circulation to cause changes in the variables in the economy and is mainly used by the central banks. For instance, during inflation, the central banks may reduce money in circulation by increasing interest rates and buy government bonds. On the other hand, fiscal policy uses the government and authorities to create changes in the macroeconomic environment. This may involve adjusting expenditure, borrowing and tax rates to monitor and influence macroeconomics. Both are equally important to the macroeconomic environment.

Since the great depression in the United States, inflation targets have been used as a monetary policy regime to reduce inflation expectations and avoid high inflation. Inflation targets are basically a monetary policy by the central bank whereby an explicit target inflation rate for a financial year is announced to the public. Starting as a credible way of reducing inflation expectations, avoiding boom and bust cycles and avoiding costs of inflation, it has grown into a problem for current economies (Zheng & Warner, 2010). It causes a high-cost push inflation, limits inflation targets, and central banks are increasingly turning a blind eye to more pressing economic problems such as unemployment. This has slowly metamorphosed into zero inflation targeting.

George Selgin describes zero inflation targeting as a dogma founded upon the assumption of a stagnant economy where the productivities of labor and capital never change (Dalamagas & Kotsios, 2008). This is true in the sense that in order to achieve zero inflation, then the economic variables have to turn into constants. This is utterly impossible, especially with the rise of globalization and constant change in currency values depending on macroeconomic changes in different parts of the world. Assuming that the economy is static, zero inflation would require stable spending, resulting in the price system managing itself and reductions in the unfair transfer of wealth to either creditors or debtors due to fluctuations between deflation and inflation. This, in turn, would have been its advantage.

Keeping in mind that the existence of a stagnant economy is an impossibility, then zero inflation targets would consequentially result in a rise in the real value of debt, whereby people will spend a higher percentage of their income on debt repayment causing a reduction in the buying power of the employed. Zero inflation targeting would also cause a rise in real interest rate making it less attractive for people to borrow and invest. This will lead to increased saving by the people stagnating economic growth. It is also a known fact that low inflation indicates low economic growth. Therefore, zero inflation target should not be the goal of any economy and is an unconstructive monetary policy in a globalized world (Singh, 2014).

A more practical approach to macroeconomic regulation is the use of fiscal policies, and the use of tax incentives is one of them. Tax incentives are a governments’ way of attracting foreign direct investment. It is a powerful tool for stimulating economic growth in the age of globalization and increasing international trade. Foreign direct investment into a country also brings with it capital, knowledge and economic transfers. This leads to an increase in employment for the people in the country, increase in government tax revenue and it encourages private sector participation in economic and social programs (Aiyagari, 1990). However, this depends on the type of tax incentives offered.

Despite its benefits, tax incentives also have their perks. Before tax incentives are given, there are usually revenue, resource allocation and enforcement and compliance costs involved in the process. Sometimes the benefits of the tax incentives are not enough to match the costs undertaken to create the incentive (Zheng & Warner, 2010). Corruption opportunities arise in the enforcement and compliance of tax incentives as many companies look for ways to benefit from the tax incentives. This creates economic distortions between foreign companies with tax incentives and local companies, resulting in a deleterious effect on the macroeconomic efficiency. Fiscal policies also take the time to effect and often undergo political interference.

However, despite its disadvantages, it is a more practical way of dealing with macroeconomic shifts in a globalized world. With the right preparation and proper enforcement legislation, tax incentives undoubtedly bear fruit. It is a far better option compared to zero inflation targeting and is crucial for the growth of any economy currently. In synergy with sane monetary policies, it is bound to achieve high employment rates, increase national income and avoid depressions due to deflation.


Aiyagari, S. R. (1990). Deflating the case for zero inflation.  Federal Reserve Bank of Minneapolis Quarterly Review 14 (3), 2-11.

Dalamagas, B., & Kotsios, S. (2008). Personal Income Tax: Incentive or Disincentive to Work Effort?  Revue économique 59 (4), 777-811.

Singh, G. (2014). Overcoming Zero Lower Bound on Interest Rate without any Inflation or Inflationary Expectations.  South Asian Journal of Macroeconomics and Public Finance 3 (1), 1-38

Zheng, L., & Warner, M. (2010). Business incentive use among US local governments: A story of accountability and policy learning.  Economic Development Quarterly 24 (4), 325-336.

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