Fiscal Policy and Learning

Evans, George W.; Honkapohja, Seppo; Mitra, Kaushik

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Fiscal Policy and Learning

CEPR Discussion Paper No. DP8891

35 Pages Posted: 4 Apr 2012

See all articles by George W. Evans

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

Kaushik Mitra

University of St. Andrews - School of Economics and Finance

There are 3 versions of this paper

Date Written: March 2012

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: Expectations, Government Spending, Permanent and temporary policy changes, Taxation

JEL Classification: D84, E21, E43, E62

Suggested Citation: Suggested Citation

Evans, George W. and Honkapohja, Seppo and Honkapohja, Seppo and Mitra, Kaushik, Fiscal Policy and Learning (March 2012). CEPR Discussion Paper No. DP8891, Available at SSRN: https://ssrn.com/abstract=2034109