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FISCAL POLICY MULTIPLIERS IN AN RBC MODEL WITH LEARNING

  • Kaushik Mitra (a1), George W. Evans (a2) and Seppo Honkapohja (a3)
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, which is in sharp contrast to the implausibly low values under RE. Positive effects of fiscal policy are demonstrated during times of economic stress like the recent Great Recession. Finally, it is shown how learning can lead to consumption and investment dynamics empirically documented during some episodes of “fiscal consolidations.”

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Corresponding author
Address correspondence to: Seppo Honkapohja, Bank of Finland, P.O. Box 160, FI 00101 Helsinki, Finland; e-mail: seppo.honkapohja@bof.fi.
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An earlier version of the paper was circulated as “Fiscal Policy and Learning.” We are very grateful for financial support from ESRC Grant RES-062-23-2617 and from National Science Foundation Grant no. SES-1025011 without which this work could not have been carried out. Useful comments from referees and an associate editor are gratefully acknowledged. Any views expressed are those of the authors and do not necessarily reflect the views of the Bank of Finland.

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Macroeconomic Dynamics
  • ISSN: 1365-1005
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