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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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    File URL: https://www.economicdynamics.org/meetpapers/2011/paper_1160.pdf
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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
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    Handle: RePEc:red:sed011:1160
    Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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    1. Alpanda, Sami & Peralta-Alva, Adrian, 2007. "Oil Crisis, Energy-Saving Technological Change and the Stock Market Crash of 1973-74," MPRA Paper 5896, University Library of Munich, Germany.
    2. 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.
    3. Casey B. Mulligan & Xavier X. Sala-i-Martin, 1997. "The Optimum Quantity of Money: Theory and Evidence," NBER Working Papers 5954, National Bureau of Economic Research, Inc.
    4. Kilian, Lutz & Lewis, Logan, 2009. "Does the Fed Respond to Oil Price Shocks?," CEPR Discussion Papers 7594, C.E.P.R. Discussion Papers.
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    6. Anton Nakov & Andrea Pescatori, 2007. "Oil and the Great Moderation," Working Paper 0717, Federal Reserve Bank of Cleveland.
    7. Sylvain Leduc & Keith Sill, 2001. "A quantitative analysis of oil-price shocks, systematic monetary policy, and economic downturns," Working Papers 01-9, Federal Reserve Bank of Philadelphia.
    8. Daniel Feenberg & James Poterba, 2003. "The Alternative Minimum Tax and Effective Marginal Tax Rates," NBER Working Papers 10072, National Bureau of Economic Research, Inc.
    9. Gilbert Ghez & Gary S. Becker, 1975. "The Allocation of Time and Goods over the Life Cycle," NBER Books, National Bureau of Economic Research, Inc, number ghez75-1, August.
    10. Martin Neil Baily, 1981. "Productivity and the Services of Capital and Labor," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1), pages 1-66.
    11. Pedro Silos & Karsten Jeske & Rajeev Dhawan, 2008. "Productivity, Energy Prices and the Great Moderation: A New Link," 2008 Meeting Papers 877, Society for Economic Dynamics.
    12. Kilian, Lutz, 2006. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," CEPR Discussion Papers 5994, C.E.P.R. Discussion Papers.
    13. Hamilton, James D, 1983. "Oil and the Macroeconomy since World War II," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 228-48, April.
    14. Chao Wei, 2003. "Energy, the Stock Market, and the Putty-Clay Investment Model," American Economic Review, American Economic Association, vol. 93(1), pages 311-323, March.
    15. Finn, Mary G, 2000. "Perfect Competition and the Effects of Energy Price Increases on Economic Activity," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 400-416, August.
    16. Gilbert Ghez & Gary S. Becker, 1975. "A Theory of the Allocation of Time and Goods Over the Life Cycle," NBER Chapters, in: The Allocation of Time and Goods over the Life Cycle, pages 1-45 National Bureau of Economic Research, Inc.
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