Policy Change and Learning in the RBC Model

62 Pages Posted: 11 Nov 2011

See all articles by Kaushik Mitra

Kaushik Mitra

University of St. Andrews - School of Economics and Finance

George W. Evans

University of Oregon - Department of Economics; University of St. Andrews - School of Economics and Finance

Seppo Honkapohja

Centre for Economic Policy Research (CEPR); Aalto University School of Business; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Aalto University - School of Business

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Date Written: November 11, 2011

Abstract

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.

Keywords: taxation, government spending, expectations, permanent and temporary policy changes

JEL Classification: E62, D84, E21, E43

Suggested Citation

Mitra, Kaushik and Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo, Policy Change and Learning in the RBC Model (November 11, 2011). Bank of Finland Research Discussion Paper No. 22/2011, Available at SSRN: https://ssrn.com/abstract=1958096 or http://dx.doi.org/10.2139/ssrn.1958096

Kaushik Mitra (Contact Author)

University of St. Andrews - School of Economics and Finance ( email )

Castlecliffe
Saint Andrews, Fife KY16 9SS
United Kingdom

George W. Evans

University of Oregon - Department of Economics ( email )

1285 University of Oregon
Eugene, OR 97403
United States
541-346-4662 (Phone)
541-346-1243 (Fax)

University of St. Andrews - School of Economics and Finance ( email )

The Scores, Castlecliff
St. Andrews, Fife KY16 8RD
United Kingdom
44-1334-462435 (Phone)

HOME PAGE: http://www.st-andrews.ac.uk/economics/staff/pages.g.evans.shtml

Seppo Honkapohja

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Aalto University School of Business ( email )

, PO Box 21210
Aalto FI-00076
Finland

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Aalto University - School of Business

Finland

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