Periodic Reporting for period 1 - POLICYMETRICS (Econometrics for Macroeconomic Policy Evaluation)
Reporting period: 2022-09-01 to 2024-08-31
This project develops methodology for evaluating macroeconomic policy decisions. For example, in the context of monetary policy it aims to evaluate whether interest rate decisions are appropriate and satisfy the mandate of the central bank in the best possible way. Similarly, in the context of fiscal, exchange rate and climate policy decisions, it aims to verify whether the policy maker’s choices are optimal for achieving certain objectives? And if not, which trade-offs, dynamics, variables and shocks were overlooked when setting policy?
To answer such questions, the project develops a new framework that enables the evaluation of macroeconomic policy decisions while imposing minimal assumptions on the structure of the economy. The methodology builds on insights from the econometric literature on robust inference and, in contrast to earlier reduced form approaches, fully respects the limitations imposed by the Lucas critique.
To answer such questions, the project develops a new framework that enables the evaluation of macroeconomic policy decisions while imposing minimal assumptions on the structure of the economy. The methodology builds on insights from the econometric literature on robust inference and, in contrast to earlier reduced form approaches, fully respects the limitations imposed by the Lucas critique.
During the first half of the project I have shown that for a broad class of macro models that are commonly used at central banks and policy institutions we can evaluate policy decisions using only sufficient statistics such as impulse responses and forecasts.
The advantage is that researchers and policy makers no longer need to specify and estimate any specific structural model to evaluate policy decisions, but instead they can use standard econometric methods for forecasting and impulse response analysis
to optimize policy making.
Further, we have empirically evaluated the conduct of monetary policy in the US over the last 150 years. Given a loss function that places equal weight on inflation and unemployment, our main findings were as follows: (i) we estimate large and uniform improvements in the conduct of
monetary policy, but only in the last 30 years, (ii) we cannot reject that the Fed’s reaction to recent financial shocks (notably the 2007-2008 financial crisis) was appropriate, in contrast to the “highly” sub-optimal reaction of the Fed during the Great Depression, (iii) despite
much larger realized losses in the 1920s-1930s, the performance of the early Fed is no worse than the performance of the passive Gold Standard, and (iv) the Fed’s reaction function during the 1960s-1970s is almost as sub-optimal as the reaction function of the early Fed.
Finally, we have evaluated fiscal policy decisions in the EU. Specificially, which countries placed large weight on the fiscal objectives of the EU --- as formalized in the stability and growth pact ---, relative to their own economic stance. We find substantial variations in fiscal discipline across
EU countries: southern EU countries but also France and Belgium put the least weight on the fiscal objectives, i.e. make the least effort to satisfy the SGP constraints. In contrast, Finland, Denmark, Sweden and The Netherlands are most fiscally responsible.
The advantage is that researchers and policy makers no longer need to specify and estimate any specific structural model to evaluate policy decisions, but instead they can use standard econometric methods for forecasting and impulse response analysis
to optimize policy making.
Further, we have empirically evaluated the conduct of monetary policy in the US over the last 150 years. Given a loss function that places equal weight on inflation and unemployment, our main findings were as follows: (i) we estimate large and uniform improvements in the conduct of
monetary policy, but only in the last 30 years, (ii) we cannot reject that the Fed’s reaction to recent financial shocks (notably the 2007-2008 financial crisis) was appropriate, in contrast to the “highly” sub-optimal reaction of the Fed during the Great Depression, (iii) despite
much larger realized losses in the 1920s-1930s, the performance of the early Fed is no worse than the performance of the passive Gold Standard, and (iv) the Fed’s reaction function during the 1960s-1970s is almost as sub-optimal as the reaction function of the early Fed.
Finally, we have evaluated fiscal policy decisions in the EU. Specificially, which countries placed large weight on the fiscal objectives of the EU --- as formalized in the stability and growth pact ---, relative to their own economic stance. We find substantial variations in fiscal discipline across
EU countries: southern EU countries but also France and Belgium put the least weight on the fiscal objectives, i.e. make the least effort to satisfy the SGP constraints. In contrast, Finland, Denmark, Sweden and The Netherlands are most fiscally responsible.
The main methodological findings of the project have highlighted the need for identifying the dynamic causal effects of news shocks: exogenous variation in variable that is released today about future values.
To identify such shocks more work is needed. Currently we are developing an innovation powered narrative estimation method to handle situations were very few news shocks can be recovered.
To identify such shocks more work is needed. Currently we are developing an innovation powered narrative estimation method to handle situations were very few news shocks can be recovered.