This paper demonstrates that the response of nominal interest rates to changes in inflationary expectations should lie between that predicted by the “Fisher” and “Darby” effects. The exact nature of the response will depend on the relative size of the income and capital gains tax rates, and the relative size of the derivatives of investment and savings to their respective after‐tax real rates. The other major conclusion of this paper is that capital gains taxation offsets the negative effect on investment produced by treating depreciation on a historic rather than a replacement cost basis.

Myths and legends about the Great Depression have dominated the public's perception of the business cycle. They have shaped government policy and, until recently, they have even held powerful sway among economists. In the immediate aftermath of the Great Depression, many economists came to question the fundamental concept of economic equilibrium. Velocity was thought to be highly unstable -as in the case of the liquidity trap-so that the quantity of money supplied was consistent with any level of nominal income. In the real sector, there was the frightening specter of underemployment