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Atlanta Fed Working Papers

The McKenna Rule and U.K. World War I Finance

James M. Nason and Shaun P. Vahey
Working Paper 2007-3
February 2007

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The United Kingdom employed the McKenna rule to conduct fiscal policy during World War I (WWI) and the interwar period. Named for Reginald McKenna, Chancellor of the Exchequer (1915–16), the McKenna rule committed the United Kingdom to a path of debt retirement, which we show was forward-looking and smoothed in response to shocks to the real economy and tax rates. The McKenna rule was in the tradition of the “English method” of war finance because the United Kingdom taxed capital to finance WWI. Higher rates of capital taxation also paid for debt retirement during and subsequent to WWI. The United Kingdom was motivated to implement the McKenna rule because of a desire to achieve a balance between fairness and equity. However, the McKenna rule adversely affected the real economy, according to a permanent income model. WWI and interwar U.K. data support the prediction that real activity is lower in response to higher past debt retirement rates.

JEL classification: E6, N4

Key words: war finance, McKenna rule, debt retirement, capital income tax rate, permanent income

The authors thank Ellis Tallman for many useful comments. Annie Tilden and Kateryna Rakowsky provided excellent research assistance. The views expressed here are the authors’ and not necessarily those of the Federal Reserve Bank of Atlanta, the Federal Reserve System, the Reserve Bank of New Zealand, Norges Bank, or their respective staffs. Any remaining errors are the authors’ responsibility.

Please address questions regarding content to James M. Nason, Federal Reserve Bank of Atlanta, Research Department, 1000 Peachtree Street, N.E., Atlanta, GA 30309,, or Shaun P. Vahey, Norges Bank, Research Department, Bankplassen 2, N – 0107, Oslo, Norway,

For further information, contact the Public Affairs Department, Federal Reserve Bank of Atlanta, 1000 Peachtree Street, N.E., Atlanta, Georgia 30309-4470, 404-498-8020.

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