Taxes and the Fed: Theory and Evidence from Equities

72 Pages Posted: 13 Oct 2017 Last revised: 15 Dec 2017

See all articles by Anthony M. Diercks

Anthony M. Diercks

Board of Governors of the Federal Reserve System

William Waller

Tulane University - Finance & Economics

Multiple version iconThere are 2 versions of this paper

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 M. Diercks (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

William Waller

Tulane University - Finance & Economics ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States

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