Fiscal Policy and Learning
George W. Evans
University of Oregon - Department of Economics; University of Saint Andrews - School of Economics and Finance
Bank of Finland; Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
University of Saint Andrews - School of Economics & Finance
CEPR Discussion Paper No. DP8891
What is the impact of surprise and anticipated policy changes when agents form expectations using adaptive learning rather than rational expectations? We examine this issue using the standard stochastic real business cycle model with lump-sum taxes. Agents combine knowledge about future policy with econometric forecasts of future wages and interest rates. Both permanent and temporary policy changes are analyzed. Dynamics under learning can have large impact effects and a gradual hump-shaped response, and tend to be prominently characterized by oscillations not present under rational expectations. These fluctuations reflect periods of excessive optimism or pessimism, followed by subsequent corrections.
Number of Pages in PDF File: 35
Keywords: Expectations, Government Spending, Permanent and temporary policy changes, Taxation
JEL Classification: D84, E21, E43, E62working papers series
Date posted: April 4, 2012
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