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Fiscal policy and learning

Listed author(s):
  • Mitra, Kaushik
  • Evans, George W.
  • Honkapohja, Seppo

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." JEL classification: E62, D84, E21, E43 Key words: Government Purchases, Expectations, Output Multiplier, Fiscal Consolidation, Taxation

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Paper provided by Bank of Finland in its series Research Discussion Papers with number 5/2012.

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Date of creation: 26 Jan 2012
Publication status: Published in Published as Fiscal Policy Multipliers in an RBC Model with Learning, Macroeconomic Dynamics, 2017: Online First
Handle: RePEc:bof:bofrdp:2012_005
Contact details of provider: Postal:
Bank of Finland, P.O. Box 160, FI-00101 Helsinki, Finland

Web page: http://www.suomenpankki.fi/en/

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