DP13765 Identifying Modern Macro Equations with Old Shocks

Author(s): Régis Barnichon, Geert Mesters
Publication Date: May 2019
Keyword(s): Impulse Responses, instrumental variables, Robust inference, Structural equations
JEL(s): C14, C32, E32, E52
Programme Areas: Monetary Economics and Fluctuations
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13765

Despite decades of research, the consistent estimation of structural forward looking macroeconomic equations remains a formidable empirical challenge because of pervasive endogeneity issues. Prominent cases ---the estimation of Phillips curves, of Euler equations for consumption or output, or of monetary policy rules--- have typically relied on using pre-determined variables as instruments, with mixed success. In this work, we propose a new approach that consists in using sequences of independently identified structural shocks as instrumental variables. Our approach is robust to weak instruments and is valid regardless of the shocks' variance contribution. We estimate a Phillips curve using monetary shocks as instruments and find that conventional methods (i) substantially under-estimate the slope of the Phillips curve and (ii) over-estimate the role of forward-looking inflation expectations.