Interest income taxation, optimal monetary policy, and macroeconomic volatility

Abstract

This paper studies optimal discretionary monetary policy in an extension of the basic new Keynesian model that incorporates interest income taxation, focusing on the effect of changes in the interest income tax rate on macroeconomic volatility. Simulations show that high levels of taxation increase inflation volatility, the output gap volatility, and the unconditional expectation of the central bank's loss function.