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Monetary policy, the tax code, and the real effects of energy shocks

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  • William T. Gavin
  • Benjamin D. Keen
  • Finn E. Kydland

Abstract

This paper develops a monetary model with taxes to account for the apparently asymmetric and time-varying effects of energy shocks on output and hours worked in post-World War II U.S. data. In our model, the real effects of an energy shock are amplified when the monetary authority responds to that shock by changing its inflation objective. Specifically, higher inflation raises households? nominal capital gains taxes since those taxes are not indexed to inflation. The increase in taxes behaves as a negative wealth effect and generates an immediate decline in output, investment, and hours worked. The large drop in investment then causes a gradual but very persistent decline in the capital stock. That protracted decline in the capital stock is associated with an extended period of low productivity growth and high inflation. Those real effects from the increase in nominal capital gains taxes are magnified by the tax on nominal interest income, which is also not indexed to inflation. A prolonged period of higher inflation and lower productivity growth following a negative energy shock is consistent with the stagflation of the 1970s. The negative effects, however, subsided greatly after 1980 because the Volcker disinflation policy prevented the Fed from accommodating negative energy shocks with higher inflation.

Suggested Citation

  • William T. Gavin & Benjamin D. Keen & Finn E. Kydland, 2013. "Monetary policy, the tax code, and the real effects of energy shocks," Working Papers 1304, Federal Reserve Bank of Dallas.
  • Handle: RePEc:fip:feddwp:1304
    DOI: 10.24149/wp1304
    Note: Published as: Gavin, William T., Benjamin D. Keen and Finn E. Kydland (2015), "Monetary Policy, the Tax Code, and the Real Effects of Energy Shocks," Review of Economic Dynamics 18 (3): 694-707.
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    6. Reona Hagiwara, 2023. "Aging, Health Risk, and Interest Rates," Working Papers 2303, Waseda University, Faculty of Political Science and Economics.
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    8. Renato Agurto & Fernando Fuentes & Carlos J. García & Esteban Skoknic, 2021. "The macroeconomic impact of the electricity price: lessons from Chile," Empirical Economics, Springer, vol. 60(5), pages 2407-2428, May.
    9. Yuzran Bustamar & Ian Lange & Elizabeth Van Wie Davis, 2017. "Characteristic of Successful Energy Policy from Politics, Economics, Social and Technological Perspective - a qualitative analysis," Working Papers 2017-10, Colorado School of Mines, Division of Economics and Business.

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    More about this item

    Keywords

    Business cycles; Fiscal policy;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory

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