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

No 5/2012:
Fiscal policy and learning

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

Abstract: 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 leaning can lead to dynamics empirically documented during episodes of "fiscal consolidations".

Keywords: government purchases; expectations; output multiplier; fiscal consolidation; taxation; (follow links to similar papers)

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

33 pages, January 27, 2012

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