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Fiscal Policy and Learning

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  • Kaushik Mitra
  • George W. Evans
  • Seppo Honkapohja

Abstract

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 learning can lead to dynamics empirically documented during episodes of "fiscal consolidations."

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File URL: http://www.st-andrews.ac.uk/economics/repecfiles/2/1202.pdf
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Bibliographic Info

Paper provided by Centre for Dynamic Macroeconomic Analysis in its series CDMA Working Paper Series with number 201202.

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Date of creation: 17 Jan 2012
Date of revision: 18 Jun 2013
Handle: RePEc:san:cdmawp:1202

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Keywords: Government Purchases; Expectations; Output Multiplier; Fiscal Consolidation; Taxation.;

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References

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  1. Campbell, John, 1994. "Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model," Scholarly Articles 3196342, Harvard University Department of Economics.
  2. Chryssi Giannitsarou, 2004. "Supply-side reforms and learning dynamics," Money Macro and Finance (MMF) Research Group Conference 2003 36, Money Macro and Finance Research Group.
  3. Michael Kumhof & Dirk Muir & Carlos de Resende & Jan in ‘t Veld & René Lalonde & Davide Furceri & Annabelle Mourougane & John Roberts & Stephen Snudden & Mathias Trabandt & Günter Coenen &, 2010. "Effects of Fiscal Stimulus in Structural Models," IMF Working Papers 10/73, International Monetary Fund.
  4. Stefano Eusepi & Bruce Preston, 2011. "Expectations, Learning, and Business Cycle Fluctuations," American Economic Review, American Economic Association, vol. 101(6), pages 2844-72, October.
  5. Stefano Eusepi & Bruce Preston, 2007. "Central Bank Communication and Expectations Stabilization," NBER Working Papers 13259, National Bureau of Economic Research, Inc.
  6. Eva Carceles-Poveda & Chryssi Giannitsarou, 2008. "Asset Pricing with Adaptive Learning," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 11(3), pages 629-651, July.
  7. Heijdra, Ben J., 2009. "Foundations of Modern Macroeconomics," OUP Catalogue, Oxford University Press, edition 2, number 9780199210695, September.
  8. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 507-535, April.
  9. Eric M. Leeper & Nora Traum & Todd B. Walker, 2011. "Clearing Up the Fiscal Multiplier Morass," NBER Working Papers 17444, National Bureau of Economic Research, Inc.
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Cited by:
  1. Kaushik Mitra & George W. Evans & Seppo Honkapohja, 2011. "Policy Change and Learning in the RBC Model," CDMA Working Paper Series 201111, Centre for Dynamic Macroeconomic Analysis.
  2. Josef Hollmayr & Christian Matthes, 2013. "Learning about fiscal policy and the effects of policy uncertainty," Working Paper 13-15, Federal Reserve Bank of Richmond.

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