Scandinavian Working Papers in Economics
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Bank of Finland Research Discussion Papers, Bank of Finland

No 22/2011:
Policy change and learning in the RBC model

Kaushik Mitra (), George W. Evans and Seppo Honkapohja ()

Abstract: 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.

Keywords: taxation; government spending; expectations; permanent and temporary policy changes; (follow links to similar papers)

JEL-Codes: D84; E21; E43; E62; (follow links to similar papers)

62 pages, November 10, 2011

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This paper is published as:
Mitra, Kaushik, George W. Evans and Seppo Honkapohja, (2013), 'Policy change and learning in the RBC model', Journal of Economic Dynamics and Control, Vol. 37, October, No. 10, pages 1947-1971

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