Download this Paper Open PDF in Browser

Taxes and the Fed: Theory and Evidence from Equities

72 Pages Posted: 13 Oct 2017 Last revised: 16 Oct 2017

Anthony M. Diercks

Board of Governors of the Federal Reserve System: Monetary and Financial Market Analysis

William Waller

Carnegie Mellon University - David A. Tepper School of Business

Date Written: 2017-10-11

Abstract

We provide a critical theoretical and empirical analysis that suggests a key driver of fiscal effects on equity markets is the Federal Reserve. For the Post-1980 era, tax cuts lead to higher cash flow news and higher discount rates. The discount rate news tends to dominate such that tax cuts are associated with lower equity returns. This result is flipped for the Pre-1980 era. Our results are confirmed across multiple measures of tax shocks (narrative, SVAR, municipal bonds, etc.) at different frequencies (daily, quarterly, annual). We motivate our empirical findings with a standard New Keynesian model (in addition to the FRB/US model) that exhibits a shift in the aggressiveness of monetary policy. Moreover in our theoretical framework, downward nominal wage rigidities account for observed asymmetries in the response to tax cuts versus tax increases.

Keywords: Federal Reserve, Fiscal policy, News Decomposition, Stock Market

JEL Classification: G0, E0, E63, G12, E5

Suggested Citation

Diercks, Anthony M. and Waller, William, Taxes and the Fed: Theory and Evidence from Equities (2017-10-11). FEDS Working Paper No. 2017-104. Available at SSRN: https://ssrn.com/abstract=3052177 or http://dx.doi.org/10.17016/FEDS.2017.104

Anthony Diercks (Contact Author)

Board of Governors of the Federal Reserve System: Monetary and Financial Market Analysis ( email )

20th and C Streets, NW
Washington, DC 20551
United States

William Waller

Carnegie Mellon University - David A. Tepper School of Business ( email )

Pittsburgh, PA
United States

Paper statistics

Downloads
58
Rank
313,864
Abstract Views
450