7. In my most controversial NY Times column, I said that what the economy needed was negative real interest rates, which could be accomplished via inflation. A temporary ITC does something similar. By temporarily reducing the effective price of capital goods, it creates expected inflation in this particular price. Under the numerical example above, the effective price of new capital would immediately fall by 20 per cent, and expected inflation would rise by 10 per cent. If nominal rates stay at zero, the real interest rate measured in units of new capital goods would become negative 10 per cent. That is one way to view the way in which a temporary ITC stimulates investment spending.
8. So much for theory, but would it work? The cash-for-clunkers program is thought by many to have promoted, or at least accelerated, car purchases. An ITC would be similar, but it would apply to business investment rather than personal cars. Instead of targeting a very narrow, politically favoured industry, it encourages investment broadly. It should have positive effects on aggregate demand in the short run and positive effects on aggregate supply in the medium and longer run.
Read all 9 reasons at Greg Mankiw’s Blog –>