Assessing Structural VAR s - PDF Free Download

... Assessing Structural VAR s by Lawrence J. Christiano, Martin Eichenbaum and Robert Vigfusson Zurich, September 2005 1

Background Structural Vector Autoregressions Address the Following Type of Question: How Does the Economy Respond to Particular Economic Shocks? 2

Background Structural Vector Autoregressions Address the Following Type of Question: How Does the Economy Respond to Particular Economic Shocks? The Answer to this Type of Question Can Be Very Useful in the Construction of Dynamic, General Equilibrium Models 3

What We Do Investigate the Sampling Properties of SVARs, When Data are Generated by Estimated DSGE Models. 6

What We Do Investigate the Sampling Properties of SVARs, When Data are Generated by Estimated DSGE Models. Bias Properties of Impulse Response Function Estimators Bias: Mean of Estimator Minus True Value of Object Being Estimated Accuracy of Standard Estimators of Sampling Uncertainty 8

What We Do... Throughout, We Assume The Identification Assumptions Motivated by Economic Theory Are Correct Example: Only Shock Driving Labor Productivity in Long Run is Technology Shock 10

What We Do... Throughout, We Assume The Identification Assumptions Motivated by Economic Theory Are Correct Example: Only Shock Driving Labor Productivity in Long Run is Technology Shock In Practice, Implementing VARs Involves Auxiliary Assumptions (Cooley- Dwyer) Example: Lag Length Specification of VARs Failure of Auxilliary Assumptions May Induce Distortions 11

What We Do... We Look at Two Classes of Identifying Restrictions 12

What We Do... We Look at Two Classes of Identifying Restrictions Long-run identification Exploit implications that some models have for long-run effects of shocks 13

What We Do... We Look at Two Classes of Identifying Restrictions Long-run identification Exploit implications that some models have for long-run effects of shocks Short-run identification Exploit model assumptions about the timing of decisions relative to the arrival of information. 14

Key Findings With Short Run Restrictions, SVARs Work Remarkably Well Inference Sharp (Sampling Uncertainty Small), Essentially No Bias. 15

Key Findings With Short Run Restrictions, SVARs Work Remarkably Well Inference Sharp (Sampling Uncertainty Small), Essentially No Bias. With Long Run Restrictions, For Model Parameterizations that Fit the Data Well, SVARs Work Well Inference is correct but not necessarily sharp. Sharpness is example specific. 16

Outline of Talk Analyze Performance of SVARs Identified with Long Run Restrictions Reconcile Our Findings for Long-Run IdentificationwithCKM Analyze Performance of SVARs Identified with Short Run Restrictions We Focus on the Question: How do hours worked respond to a technology shock? 18

A Conventional RBC Model Preferences: E 0 X t=0 (β (1 + γ)) t [log c t + ψ log (1 l t )]. Constraints: c t +(1+τ x )[(1+γ) k t+1 (1 δ) k t ] (1 τ lt ) w t l t + r t k t + T t. Shocks: c t +(1+γ) k t+1 (1 δ) k t k θ t (z t l t ) 1 θ. log z t = µ Z + σ z ε z t τ lt+1 =(1 ρ l ) τ l + ρ l τ lt + σ l ε l t+1 Information: Time t Decisions Made After Realization of All Time t Shocks 19

Long-Run Properties of Our RBC Model ε z t is only shock that has a permanent impact on output and labor productivity a t y t /l t. Exclusion property: lim [E ta t+j E t 1 a t+j ]=f(ε z t only), j Sign property: f is an increasing function. 20

Parameterizing the Model Parameters: Exogenous Shock Processes: We Estimate These Other Parameters: Same as CKM β θ δ ψ γ τ x τ l µ z 0.98 1/4 1 3 1 (1.06)1/4 2.5 1.01 1/4 1 0.3 0.243 1.02 1/4 1 Baseline Specifications of Exogenous Shocks Processes: Our Baseline Specification Chari-Kehoe-McGrattan (July, 2005) Baseline Specification 22

OurBaselineModel(KP Specification): Technology shock process corresponds to Prescott (1986): log z t = µ Z +0.011738 ε z t. 23

OurBaselineModel(KP Specification): Technology shock process corresponds to Prescott (1986): log z t = µ Z +0.011738 ε z t. Law of motion for Preference Shock, τ l,t : τ l,t =1 µ µ ct lt y t 1 l t µ ψ 1 θ (Household and Firm Labor Fonc) τ l,t = τ l +0.9934 τ l,t 1 +.0062 ε l t. Estimation Results Robust to Maximum Likelihood Estimation - Output Growth and Hours Data Output Growth, Investment Growth and Hours Data (here, τ xt is stochastic) 25

CKM Baseline Model Exogenous Shocks: also estimated via maximum likelihood log z t =0.00516 + 0.0131 ε z t τ lt = τ l +0.952τ l,t 1 +0.0136 ε l t. Note: the shock variances (particularly τ lt ) are very large compared with KP We Will Investigate Why this is so, Later 26

Estimating Effects of a Positive Technology Shock Vector Autoregression: Y t+1 = B 1 Y t 1 +... + B p Y t p + u t+1,eu t u 0 t = V, u t = Cε t, Eε t ε 0 t = I, CC 0 = V Y t = µ µ log at ε z,ε log l t = t,a t ε t = Y t 2t l t Impulse Response Function to Positive Technology Shock (ε z t ): Y t E t 1 Y t = C 1 ε z t,e t Y t+1 E t 1 Y t+1 = B 1 C 1 ε z t Need B 1,...,B p,c 1. 28

Identification Problem From Applying OLS To Both Equations in VAR, We Know : B 1,..., B p,v Problem, Need first Column of C, C 1 Following Restrictions Not Enough: CC 0 = V Identification Problem: Not Enough Restrictions to Pin Down C 1 Need More Restrictions 30

Identification Problem... Impulse Response to Positive Technology Shock (ε z t ): lim [E ta t+j E t 1 a t+j ]=(10)[I (B 1 +... + B p )] 1 C j µ ε z t, ε 2t 30

Identification Problem... Impulse Response to Positive Technology Shock (ε z t ): lim [E ta t+j E t 1 a t+j ]=(10)[I (B 1 +... + B p )] 1 C j Exclusion Property of RBC Model Motivates the Restriction: D [I (B 1 +... + B p )] 1 C = x 0 number number Sign Property of RBC Model Motivates the Restriction, x 0. DD 0 =[I (B 1 +... + B p )] 1 V I (B 1 +... + B p ) 0 1 µ ε z t, ε 2t 33

Frequency Zero Spectral Density Note: DD 0 =[I (B 1 +... + B p )] 1 V I (B 1 +... + B p ) 0 1 = S0 S 0 Is VAR-based Parametric Estimator of the Zero-Frequency Spectral Density Matrix of Data 35

Frequency Zero Spectral Density Note: DD 0 =[I (B 1 +... + B p )] 1 V I (B 1 +... + B p ) 0 1 = S0 S 0 Is VAR-based Parametric Estimator of the Zero-Frequency Spectral Density Matrix of Data An Alternative Way to Compute D 1 (and, hence, C 1 ) Is to Use a Different Estimator of S 0 S 0 = rx k= r 1 k r Ĉ (k), Ĉ(k) = 1 T TX t=k EY t Y 0 t k Modified SVAR Procedure Similar to Extending Lag Length, But Non- Parametric 35

Experiments with Estimated Models Simulate 1000 data sets, each of length 180 observations, using DSGE model as Data Generating Mechanism. On Each Data Set: Estimate a four lag VAR. Report Mean Impulse Response Function Across 1000 Synthetic data sets (Solid, Black Line) Report Mean, Plus/Minus Two Standard Deviations of Estimator (Grey area) Report Mean of Econometrician s Confidence Interval Across 1000 syntheticdatasets(circles) 35

Response of Hours to A Technology Shock Long Run Identification Assumption 2.5 KP Model 2.5 CKM Baseline Model 2 2 1.5 1.5 1 1 0.5 0.5 0 0 0.5 0.5 1 0 2 4 6 8 10 1 0 2 4 6 8 10

Diagnosing the Results WhatisGoingoninCKMExample:WhyisThereBias? 41

Diagnosing the Results WhatisGoingoninCKMExample:WhyisThereBias? Problem Lies in DifficultyofEstimatingtheSumofVARCoefficients. Recall: C 1 = f LR (V,B 1 +... + B p ) Regressions Only Care About B 1 +... + B q IfThereisLotsofPowerat Low Frequencies CKM Example Would Have Had Less Bias if: If VAR Was Better at Low-Frequency Part of Estimation If there Were More Low-Frequency Power in CKM Example 43

Modified Long-run SVAR Procedure Replace Ŝ0 Implicit in Standard SVAR Procedure, with Non-parametric Estimator of S 0 25

CKM Baseline Model 2 1.5 1 0.5 0 0.5 2 1.5 1 0.5 0 0.5 1 0 2 4 6 8 10 1 0 2 4 6 8 10

The Importance of Power at Low Frequencies Preference Shock in CKM Example: τ lt = τ l +0.952τ l,t 1 +0.0136 ε l t. Replace it with: where τ lt = τ l +0.995τ l,t 1 + σ ε l t, σ adjusted so Variance(τ lt ) Unchanged 45

2 1.5 1 0.5 0 0.5 1 0 2 4 6 8 10 CKM Baseline Model except ρ l = 0.995 with la 2 1.5 1 0.5 0 0.5 1 0 2 4 6 8 10

Reconciling with CKM CKM Conclude Long-run SVARs Not Fruitful for Building DSGE Models. We Disagree: Two Reasons The Data Overwhelmingly Reject CKM s Parameterization Even if the World Did Correspond to One of CKM s Examples, No Econometrician Would Be Misled A Feature of CKM Examples is That Econometrician s Standard Errors are Huge 41

CKM Model Embeds a Remarkable Assumption Basic Procedure: Maximum Likelihood with Measurement Error Core Estimation Assumption: Technology Growth Well Measured by g t (!!!!) g t government consumption plus net exports This assumption drives their parameter estimates and is overwhelmingly rejected by the data. CKM also consider models with more shocks: but, always retain baseline model specification for technology and preference shocks 24

CKM Baseline Model is Rejected by the Data CKM estimate their Baseline Model using MLE with Measurement Error. Let Y t =( log y t, log l t, log i t, log G t ) 0, Observer Equation: Y t = X t + u t,eu t u 0 t = R, R is a diagonal matrix, u t : 4 1 vector of iid measurement error, X t : model implications for Y t 42

CKM Baseline Model is Rejected by the Data... CKM Allow for Four Shocks. (τ l,t,z t,τ xt,g t ) G t = g t z t CKM fix the elements on the diagonal of R to equal 1/100 Var(Y t ) 43

CKM Baseline Model is Rejected by the Data... CKM Allow for Four Shocks. (τ l,t,z t,τ xt,g t ) G t = g t z t CKM fix the elements on the diagonal of R to equal 1/100 Var(Y t ) For Purposes of Estimating the Baseline Model, Assume: So, g t = ḡ, τ xt = τ x. log G t = log z t + small measurement error t. 44

CKM Baseline Model is Rejected by the Data... Overwhelming Evidence Against CKM Baseline Model Likelihood Ratio Statistic Likelihood Value (degrees of freedom) Estimated model 328 Freeing Measurement Error on g = z 2159 4974 (1) Freeing All Four Measurement Errors 2804 6264 (4) Evidence of Bias in Estimated CKM Model Reflects CKM Choice of Measurement Error Free Up Measurement error on g = z Produces Model With Good Bias Properties: Similar to KP Benchmark Model 46

The Role of g CKM Baseline Estimated measurement error in g 2 1.5 1 0.5 0 0.5 0 2 4 6 8 10 2 1.5 1 0.5 0 0.5 0 2 4 6 8 10 Baseline KP Model 2 1.5 1 0.5 0 0.5 0 2 4 6 8 10

CKM Assert that SVARs Perform Poorly for Large Range of Parameter Values Problem With CKM Assertion Allegation Applies only to Parameter Values that are Extremely Unlikely Even in the Extremely Unlikely Region, Econometrician Who Looks at Standard Errors is Innoculated from Error 50

1550 1540 Concentrated Likelihood Function Figure A6 Combined Error in the Mean Impact Coefficient (solid line) and the Mean of 95% Bootstrapped Confidence Bands (dashed lines) Averaged Across 1,000 Applications of the Four-Lag LSVAR Procedure with ρ =.99 to Model Simulations of Length 180, Varying the Ratio of Innovation Variances 400 1530 300 200 1520 Percent Error 100 0-100 1510-200 -300 1500-400 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 Ratio of Innovation Variances (σ 2 l /σ 2 z ) 1490 NOTE: The combined error is defined to be the percent error in the small sample SVAR response of hours to technology on impact relative to the model s theoretical response. This error combines the specification error and the small sample bias. 1480 0 0.5 1 1.5 2 Ratio of Innovation Variances (σ / σ ) 2 l z

A Summing Up So Far With Long Run Restrictions, For RBC Models that Fit the Data Well, Structural VARs Work Well Examples Can Be Found With Some Bias Reflects Difficulty of Estimating Sum of VAR Coefficients Bias is Small Relative to Sampling Uncertainty Econometrician Would Correctly Assess Sampling Uncertainty Golden Rule: Pay Attention to Standard Errors! 52

Turning to SVARS with Short Run Identifying Restrictions Bulk of SVAR Literature Concerned with Short-Run Identification 53

Turning to SVARS with Short Run Identifying Restrictions Bulk of SVAR Literature Concerned with Short-Run Identification Substantive Economic Issues Hinge on Accuracy of SVARs with Short-run Identification Ed Green s Review of Mike Woodford s Recent Book on Monetary Economics Recent Monetary DSGE Models Deviate from Original Rational Expectations Models (Lucas-Prescott, Lucas, Kydland-Prescott, Long-Plosser, and Lucas-Stokey) By Incorporating Various Frictions. 55

SVARS with Short Run Identifying Restrictions Adapt our Conventional RBC Model, to Study VARs Identified with Short-run Restrictions Results Based on Short-run Restrictions Allow Us to Diagnose Results Based on Long-run Restrictions Recursive version of the RBC Model First, τ lt is observed Second, labor decision is made. Third, other shocks are realized. Then, everything else happens. 58

The Recursive Version of the RBC Model Key Short Run Restrictions: log l t = f (ε l,t, lagged shocks) log Y t l t = g (ε z t,ε l,t, lagged shocks), Recover ε z t : Regress log Y t l t on log l t Residual is measure of ε z t. This Procedure is Mapped into an SVAR identified with a Choleski decompostion of ˆV. 59

The Recursive Version of the RBC Model... The Estimated VAR: Y t = B 1 Y t 1 + B 2 Y t 2 +... + B p Y t p + u t,eu t u 0 t = V u t = Cε t,cc 0 = V. µ ε z C =[C 1.C 2 ],ε t = t ε 2t Impulse Response Response Functions Require: B 1,...,B p,c 1 Short-run Restrictions Uniquely Pin Down C 1 : ³ C 1 = f SR ˆV Note: Sum of VAR Coefficients Not Needed 60

Response of Hours to A Technology Shock KP Model Short Run Identification Assumption CKM Baseline Model 0.8 0.6 0.4 0.2 0 0.2 0.8 0.6 0.4 0.2 0 0.2 0 2 4 6 8 10 0 2 4 6 8 10

SVARs with Short Run Restrictions Perform remarkably well Inference is Sharp and Correct 62

VARs and Models with Nominal Frictions Data Generating Mechanism: an estimated DSGE model embodying nominal wage and price frictions as well as real and monetary shocks ACEL (2004) Three shocks Neutral shock to technology, Shock to capital-embodied technology Shock to monetary policy. Each shock accounts for about 1/3 of cyclical output variance in the model 65

Analysis of VARS using the ACEL model as DGP Neutral Technology Shock 0.6 Investment Specific Technology Shock 0.5 0.4 0.3 0.2 0.1 0 0 2 4 6 8 10 Monetary Policy Shock 0.5 0.4 0.3 0.2 0.1 0 0 2 4 6 8 10 0.4 0.3 0.2 0.1 0 0.1 0 2 4 6 8 10

Continuing Work with Models with Nominal Frictions ACEL (2004) Assesses Bias Properties in VARs with Many More Variables Requires Expanding Number of Shocks Results So Far are Mixed Could Be an Artifact of How We Introduced Extra Shocks We are Currently Studying This Issue. 50

Conclusion SVARs Address Question: How Does Economy Respond to a Particular Shock? When the Data Contain A Lot of Information: SVAR s Provide a Reliable Answer When the Data Contain Little Information: SVARs Indicate this Correctly, Buy Delivering Large (Accurate) Standard Errors 78

Conclusion... In Case of Short Run Restrictions Answer is Typically There is Enough Information to Answer the Question Reliably In Case of Long-Run Restrictions: Answer is Often, There Isn t Enough Information to Answer the Question Reliably Still, there are Examples Where SVARs Do Pick Up Useful Information. 79

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