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Fiscal Policy and Learning

  • Kaushik Mitra
  • George W. Evans
  • Seppo Honkapohja

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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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
Contact details of provider: Postal: School of Economics and Finance, University of St. Andrews, Fife KY16 9AL
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  1. Heijdra, Ben J., 2009. "Foundations of Modern Macroeconomics," OUP Catalogue, Oxford University Press, edition 2, number 9780199210695.
  2. Cogan, John F. & Cwik, Tobias & Taylor, John B. & Wieland, Volker, 2009. "New Keynesian versus old Keynesian government spending multipliers," Working Paper Series 1090, European Central Bank.
  3. John C Williams & Athanasios Orphanides, 2005. "Robust Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2005 400, Society for Computational Economics.
  4. King, R.G. & Baxter, M., 1990. "Fiscal Policy In General Equilibrium," RCER Working Papers 244, University of Rochester - Center for Economic Research (RCER).
  5. Roberto Perotti, 1999. "Fiscal Policy In Good Times And Bad," The Quarterly Journal of Economics, MIT Press, vol. 114(4), pages 1399-1436, November.
  6. Robert G. King & Sergio T. Rebelo, 2000. "Resuscitating Real Business Cycles," RCER Working Papers 467, University of Rochester - Center for Economic Research (RCER).
  7. Carceles-Poveda, Eva & Giannitsarou, Chryssi, 2007. "Asset Pricing with Adaptive Learning," CEPR Discussion Papers 6223, C.E.P.R. Discussion Papers.
  8. Athanasios Orphanides amd John Williams, 2001. "Monetary Policy with Imperfect Knowledge," Computing in Economics and Finance 2001 254, Society for Computational Economics.
  9. Giuseppe Bertola & Allan Drazen, 1991. "Trigger Points and Budget Cuts: Explaining the Effects of Fiscal Austerity," NBER Working Papers 3844, National Bureau of Economic Research, Inc.
  10. Lawrence Christiano & Martin Eichenbaum & Sergio Rebelo, 2011. "When Is the Government Spending Multiplier Large?," Journal of Political Economy, University of Chicago Press, vol. 119(1), pages 78 - 121.
  11. Fabio Milani, 2005. "Expectations, Learning and Macroeconomic Persistence," Working Papers 050608, University of California-Irvine, Department of Economics.
  12. Stefano Eusepi & Bruce Preston, 2008. "Expectations, Learning and Business Cycle Fluctuations," NBER Working Papers 14181, National Bureau of Economic Research, Inc.
  13. 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.
  14. Evans, George W. & Honkapohja, Seppo & Marimon, Ramon, 1996. "Convergence in Monetary Inflation Models with Heterogeneous Learning Rules," CEPR Discussion Papers 1310, C.E.P.R. Discussion Papers.
  15. 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 & Susanna, 2010. "Effects of Fiscal Stimulus in Structural Models," IMF Working Papers 10/73, International Monetary Fund.
  16. Campbell, John, 1994. "Inspecting the Mechanism: An Analytical Approach to the Stochastic Growth Model," Scholarly Articles 3196342, Harvard University Department of Economics.
  17. Francesco Giavazzi & Marco Pagano, 1990. "Can Severe Fiscal Contractions be Expansionary? Tales of Two Small European Countries," NBER Working Papers 3372, National Bureau of Economic Research, Inc.
  18. Giannitsarou, Chryssi, 2006. "Supply-side reforms and learning dynamics," Journal of Monetary Economics, Elsevier, vol. 53(2), pages 291-309, March.
  19. S. Rao Aiyagari & Lawrence J. Christiano & Martin Eichenbaum, 1990. "The Output, Employment, and Interest Rate Effects of Government Consumption," NBER Working Papers 3330, National Bureau of Economic Research, Inc.
  20. Preston, Bruce, 2006. "Adaptive learning, forecast-based instrument rules and monetary policy," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 507-535, April.
  21. Maria Gabriella Briotti, 2005. "Economic reactions to public finance consolidation - a survey of the literature," Occasional Paper Series 38, European Central Bank.
  22. Eva Carceles-Poveda & Chryssi Giannitsarou, 2007. "Online Appendix to Asset Pricing with Adaptive Learning," Technical Appendices carceles08, Review of Economic Dynamics.
  23. repec:clu:wpaper:0708-10 is not listed on IDEAS
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