Working Paper: CEPR ID: DP8891
Authors: George W. Evans; Seppo Honkapohja; Kaushik Mitra
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: Expectations; Government Spending; Permanent and Temporary Policy Changes; Taxation
JEL Codes: D84; E21; E43; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| adaptive learning (D84) | output multipliers (E23) |
| RE (L85) | output multipliers (E23) |
| adaptive learning (D84) | crowding in of investment (E22) |
| RE (L85) | crowding out of consumption (E21) |
| fiscal policy changes (E62) | output multipliers (E23) |