DP8891 Fiscal Policy and Learning
|Author(s):||George W. Evans, Seppo Honkapohja, Kaushik Mitra|
|Publication Date:||March 2012|
|Keyword(s):||Expectations, Government Spending, Permanent and temporary policy changes, Taxation|
|JEL(s):||D84, E21, E43, E62|
|Programme Areas:||International Macroeconomics|
|Link to this Page:||cepr.org/active/publications/discussion_papers/dp.php?dpno=8891|
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.