Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/187489
Authors: 
Koulovatianos, Christos
Mavridis, Dimitris
Year of Publication: 
2018
Series/Report no.: 
CFS Working Paper Series No. 614
Abstract: 
Based on OECD evidence, equity/housing-price busts and credit crunches are followed by substantial increases in public consumption. These increases in unproductive public spending lead to increases in distortionary marginal taxes, a policy in sharp contrast with presumably optimal Keynesian fiscal stimulus after a crisis. Here we claim that this seemingly adverse policy selection is optimal under rational learning about the frequency of rare capital-value busts. Bayesian updating after a bust implies massive belief jumps toward pessimism, with investors and policymakers believing that busts will be arriving more frequently in the future. Lowering taxes would be as if trying to kick a sick horse in order to stand up and run, since pessimistic markets would be unwilling to invest enough under any temporarily generous tax regime.
Subjects: 
Bayesian learning
controlled diffusions and jump processes
learning about jumps
Gamma distribution
rational learning
JEL: 
H30
D83
C11
D90
E21
D81
C61
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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