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Mrs. Sarwat Jahan, Ahmed Saber Mahmud, and Mr. Chris Papageorgiou

For the latest thinking about the international financial system, monetary policy, economic development, poverty reduction, and other critical issues, subscribe to Finance & Development (F&D). This lively quarterly magazine brings you in-depth analyses of these and other subjects by the IMF’s own staff as well as by prominent international experts. Articles are written for lay readers who want to enrich their understanding of the workings of the global economy and the policies and activities of the IMF.

Mr. Jaromir Benes, Kevin Clinton, Asish George, Joice John, Mr. Ondra Kamenik, Mr. Douglas Laxton, Pratik Mitra, G.V. Nadhanael, Hou Wang, and Fan Zhang
India formally adopted flexible inflation targeting (FIT) in June 2016 to place price stability, defined in terms of a target CPI inflation, as the primary objective of monetary policy. In this context, the paper draws on Indian macroeconomic developments since 2000 and the experience of other countries that adopted FIT to bring out insights on how credible policy with an emphasis on a strong nominal anchor can reduce the impact of supply shocks and improve macroeconomic stability. For illustrating the key issues given the unique structural characteristics of India and the policy options under an FIT framework, the paper describes an analytical framework using the core quarterly projection model (QPM). Simulations of the QPM are carried out to illustrate the monetary policy responses under different types of uncertainty and to bring out the importance of gaining credibility for improving monetary policy efficacy.
Benjamin Carton, Emilio Fernández Corugedo, and Mr. Benjamin L Hunt
This paper uses a multi-region, forward-looking, DSGE model to estimate the macroeconomic impact of a tax reform that replaces a corporate income tax (CIT) with a destination-based cash-flow tax (DBCFT). Two key channels are at play. The first channel is the shift from an income tax to a cash-flow tax. This channel induces the corporate sector to invest more, boosting long-run potential output, GDP and consumption, but crowding out consumption in the short run as households save to build up the capital stock. The second channel is the shift from a taxable base that comprises domestic and foreign revenues, to one where only domestic revenues enter. This leads to an appreciation of the currency to offset the competitiveness boost afforded by the tax and maintain domestic investment-saving equilibrium. The paper demonstrates that spillover effects from the tax reform are positive in the long run as other countries’ exports benefit from additional investment in the country undertaking the reform and other countries’ domestic demand benefits from improved terms of trade. The paper also shows that there are substantial benefits when all countries undertake the reform. Finally, the paper demonstrates that in the presence of financial frictions, corporate debt declines under the tax reform as firms are no longer able to deduct interest expenses from their profits. In this case, the tax shifting results in an increase in the corporate risk premia, a near-term decline in output, and a smaller long-run increase in GDP.