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The Effects of Fiscal Policy When Planning Horizons are Finite

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  • JOEP LUSTENHOUWER
  • KOSTAS MAVROMATIS

Abstract

We study the importance of planning horizons for fiscal multipliers in a New‐Keynesian model with bounded rationality. We show that, when agents have shorter planning horizons, government spending multipliers are smaller, whereas labor tax cut multipliers are larger. Furthermore, Ricardian equivalence breaks down, and transfer shocks feature a negative multiplier. Results are driven by the cognitive limitations of finite planning horizons that lead agent's expectations to deviate from the fully rational benchmark. We find larger investment responses, which are more in line with empirical findings than those of models with longer planning horizons, rule‐of‐thumb households, or a Blanchard–Yaari structure.

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  • Joep Lustenhouwer & Kostas Mavromatis, 2025. "The Effects of Fiscal Policy When Planning Horizons are Finite," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 57(2-3), pages 549-582, March.
    • Handle: RePEc:wly:jmoncb:v:57:y:2025:i:2-3:p:549-582
    DOI: 10.1111/jmcb.13100
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    1. Gancho Ganchev & Ivan Todorov, 2021. "Taxation, government spending and economic growth: The case of Bulgaria," Journal of Tax Reform, Graduate School of Economics and Management, Ural Federal University, vol. 7(3), pages 255-266.

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    More about this item

    JEL classification:

    • E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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