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

William Gavin (), Benjamin Keen and Finn Kydland

No 1304, Working Papers from Federal Reserve Bank of Dallas

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.

Keywords: Business cycles; Fiscal policy (search for similar items in EconPapers)
Pages: 25 pages
Date: 2013
New Economics Papers: this item is included in nep-dge, nep-mac, nep-mon and nep-pbe
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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Citations: View citations in EconPapers (1)

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Related works:
Journal Article: Monetary Policy, the Tax Code, and the Real Effects of Energy Shocks (2015)
Working Paper: Monetary policy, the tax code, and the real effects of energy shocks (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:feddwp:1304

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DOI: 10.24149/wp1304

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