This paper analyzes the interaction of inflation with the tax code and its contribution
to aggregate fluctuations. We find significant effects operating through the tax
on realized nominal capital gains. A tax on nominal bond income magnifies these effects.
Our innovation is to combine monetary policy shocks with non-indexed taxes in a model
where the central bank implements policy using an interest rate rule. Monetary policy
had important effects on the behavior of the business cycle before 1980 because policymakers
did not exert effective control over inflation. Monetary policy reform around 1980
led to better control, and with more stable inflation, the effect of the interaction
between monetary policy and the nominal capital gains tax has become negligible.
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