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Monetary Policy, Taxes, and the Business Cycle

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  • Michael R. Pakko
  • William T. Gavin
  • Finn E. Kydland

Abstract

In this paper we model the contribution of monetary growth shocks to aggregate fluctuations. Our innovation is to combine persistent money growth shocks with taxes on nominal capital gains in a model in which the central bank operates policy using an interest rate rule. All three features are necessary for us to generate large effects of monetary shocks, but they are also realistic features of the U.S. economy. All three have been examined in isolation and, by themselves, do not contribute much to aggregate fluctuations. Capital gains taxes are important when there are persistent changes in the inflation rate. Money growth shocks do not cause persistence changes in inflation when the central bank uses a money growth rule. When the central bank operates policy using an interest rate rule persistent money growth shocks do lead to persistence in inflation, raising both the nominal value of capital and the effective marginal capital gains tax rate.

Suggested Citation

  • Michael R. Pakko & William T. Gavin & Finn E. Kydland, 2004. "Monetary Policy, Taxes, and the Business Cycle," Computing in Economics and Finance 2004 32, Society for Computational Economics.
    • Handle: RePEc:sce:scecf4:32
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    2. Accolley, Delali, 2018. "Accounting for Busines Cycles in Canada: II. The Role of Money," MPRA Paper 85481, University Library of Munich, Germany.
    3. Anagnostopoulos, Alexis & Cárceles-Poveda, Eva & Lin, Danmo, 2012. "Dividend and capital gains taxation under incomplete markets," Journal of Monetary Economics, Elsevier, vol. 59(7), pages 599-611.
    4. Panagiotis Chronis & Aspassia Strantzalou, 2008. "Monetary and Fiscal Policy Interaction: What is the Role of the Transaction Cost of the Tax System in Stabilisation Policies?," Working Papers 71, Bank of Greece.
    5. William Gavin & Benjamin Keen & Finn Kydland, 2015. "Monetary Policy, the Tax Code, and the Real Effects of Energy Shocks," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(3), pages 694-707, July.
    6. Alexis Anagnostopoulos & Orhan Erem Atesagaoglu & Eva Cárceles‐Poveda, 2022. "Financing corporate tax cuts with shareholder taxes," Quantitative Economics, Econometric Society, vol. 13(1), pages 315-354, January.
    7. Anatoliy Belaygorod & Michael J. Dueker, 2005. "Discrete monetary policy changes and changing inflation targets in estimated dynamic stochastic general equilibrium models," Review, Federal Reserve Bank of St. Louis, vol. 87(Nov), pages 719-734.
    8. Reona Hagiwara, 2023. "Aging, Health Risk, and Interest Rates," Working Papers 2303, Waseda University, Faculty of Political Science and Economics.
    9. Matheus Cardoso Leal & Marcio Issao Nakane, 2022. "Brazilian economy in the 2000’s: A tale of two recessions," Working Papers, Department of Economics 2022_20, University of São Paulo (FEA-USP).
    10. Zeida, Teegawende H., 2019. "On the corporate tax reform: Coordination and trade-offs," Journal of Macroeconomics, Elsevier, vol. 62(C).
    11. Alexis Anagnostopoulos & Orhan Erem Atesagaoglu & Eva Carceles-Poveda, 2014. "On the Double Taxation of Corporate Profits," Department of Economics Working Papers 14-03, Stony Brook University, Department of Economics.
    12. Orhan Atesagaoglu & Eva Carceles-Poveda & Alexis Anagnostopoulos, 2014. "Capital Income Taxation with Household and Firm Heterogeneity," 2014 Meeting Papers 525, Society for Economic Dynamics.
    13. Simon Bösenberg & Peter Egger & Benedikt Zoller-Rydzek, 2018. "Capital taxation, investment, growth, and welfare," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 25(2), pages 325-376, April.
    14. Finn E. Kydland & Fei Mao & William T. Gavin, 2011. "Monetary Policy, the Tax Code, and Energy Price Shocks," 2011 Meeting Papers 1160, Society for Economic Dynamics.
    15. Wilson, Matthew S., 2020. "A real business cycle model with money as a sunspot variable," Journal of Economics and Business, Elsevier, vol. 109(C).
    16. Brinca, Pedro & Costa-Filho, João & Loria, Francesca, 2020. "Business Cycle Accounting: what have we learned so far?," MPRA Paper 100180, University Library of Munich, Germany.
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    More about this item

    Keywords

    Inflation; Taxation; Business Cycle;
    All these keywords.

    JEL classification:

    • E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E42 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Monetary Sytsems; Standards; Regimes; Government and the Monetary System

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