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Monetary Policy, the Tax Code, and Energy Price Shocks

Author

Listed:
  • 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)

Abstract

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.

Suggested Citation

  • 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.
    • Handle: RePEc:red:sed011:1160
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    References listed on IDEAS

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