Balanced budget tax cuts in a liquidity-constrained economy

This paper modifies the basic model of Kiyotaki and Moore by introducing a government that levies distortionary taxes on wages and dividends, spends exactly its tax revenue and holds money supply constant. Discretionary across the board tax cuts relieve the effects of liquidity constraints that limit investment, and thereby stimulate economic activity in normal times. A discretionary cut in the rate of tax on dividends ameliorates the effects of an exogenous tightening of liquidity constraints, without unnecessary distortions, and is thus an alternative policy to the equity purchase programme proposed by Kiyotaki and Moore.