Fiscal Policy and Learning
35 Pages Posted: 31 Jan 2012
Date Written: January 26, 2012
Using the standard real business cycle model with lump-sum taxes, we analyze the impact of fiscal policy when agents form expectations using adaptive learning rather than rational expectations (RE). The output multipliers for government purchases are significantly higher under learning, and fall within empirical bounds reported in the literature (in sharp contrast to the implausibly low values under RE). Effectiveness of fiscal policy is demonstrated during times of economic stress like the recent Great Recession. Finally it is shown how leaning can lead to dynamics empirically documented during episodes of "fiscal consolidations".
Keywords: government purchases, expectations, output multiplier, fiscal consolidation, taxation
JEL Classification: E62, D84, E21, E43
Suggested Citation: Suggested Citation