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Monetary Policy, the Tax Code, and Energy Price Shocks

  • Finn E. Kydland

    (University of California, Santa Barbara)

  • Fei Mao

    (Federal Reserve Bank of St. Louis)

  • William T. Gavin

    (Federal Reserve Bank of St. Louis)

Registered author(s):

    This paper analyzes the effect of energy price shocks on business cycle fluctuations in a model with monetary policy and a tax code. The tax code includes a tax on realized nominal capital gains. When the monetary regime allows energy price shocks to affect long run inflation expectations, oil price shocks have an immediate and large impact on output and hours worked because changes in the expected inflation rate change the expected effective tax rate on capital gains. A tax on interest income magnifies the effect of all shocks on interest rates and inflation. The model helps to explain why the effect of energy price shocks was so large before 1980 and why the effect disappeared afterwards. The measurable real effects of monetary policy work through the interaction of inflation with the imperfectly indexed tax code.

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    Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 1160.

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    Date of creation: 2011
    Date of revision:
    Handle: RePEc:red:sed011:1160
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    Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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