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Monetary policy, taxes, and the business cycle

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

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.

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Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 54 (2007)
Issue (Month): 6 (September)
Pages: 1587-1611

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Handle: RePEc:eee:moneco:v:54:y:2007:i:6:p:1587-1611
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505566

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