Supply-side reforms and learning dynamics

This paper studies the nature, the magnitude and the length of the transition after a capital tax cut. The transition is analysed with adaptive learning, under which agents do not need to adjust instantaneously to the change, as with rational expectations (RE). Impulse response analysis reveals that the transition with learning is asymmetrically sensitive to the nature of the exogenous technological shock at the time of the reform. If the reform coincides with a negative shock, the transition to the new steady state is slow, whereas, if it coincides with a positive shock, it is approximately the same as the one predicted by RE. The results imply that cutting capital income taxes before or during a recession may not be an effective means for short-run fiscal stimulus.