What Impulse Response Do Instrumental Variables Estimate

Bonsoo Koo (Monash University, Australia)
Thursday 18 Nov 2021, 12:00 - 13:00
Spoken Language
Online (Zoom)
Campus Woudestein
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Instrumental variables (IV) are often used to identify impulse responses of a shock to macroeconomic variables. We observe that a macroeconomic shock can be a composite of various shock elements, each of which may well have heterogeneous correlation with the instrument.

The correlation is conventionally assumed to be homogeneous across elements, and so is the identified impulse response. By accommodating the macroeconomic variable’s heterogeneous responses to diverse shock elements in the structural vector moving average model, we show that the conventional local projection IV estimand of the impulse response, in general, does not identify a meaningful quantity.

Only under the condition that the correlation between the instrument and each of the shock elements has the same sign, the IV estimand identifies an instrument-specific weighted average of impulse responses of shock elements to the macroeconomic variable of interest, comparable to the local average treatment effect in microeconometrics. Furthermore, we provide conditions under which (1) the component impulse responses are point-identified and (2) they are identified up to a specific bound without the sign restriction.

We show that the US non-defense spending multiplier can be larger than the unity contrary to the much smaller magnitude of an aggregate multiplier identified by the military news instrument in Ramey and Zubairy (2018, Journal of Political Economy.


If you would like to participate in the seminar, please send an email to the secretariat of Econometrics, eb-secr@ese.eur.nl.

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Secretariat Econometrics

Phone: +31 (0)10 408 12 59/ 12 64
Email: eb-secr@ese.eur.nl

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