Title

Instrumental Variable Identification of Dynamic Variance Decompositions

Author(s)

Mikkel Plagborg-Møller Mikkel Plagborg-Møller (Princeton University)

Christian K. Wolf Christian Wolf (MIT and NBER)

Abstract

Macroeconomists increasingly use external sources of exogenous variation for causal inference. However, unless such external instruments (proxies) capture the underlying shock without measurement error, existing methods are silent on the importance of that shock for macroeconomic fluctuations. We show that, in a general moving average model with external instruments, variance decompositions for the instrumented shock are interval-identified, with informative bounds. Various additional restrictions guarantee point identification of both variance and historical decompositions. Unlike SVAR analysis, our methods do not require invertibility. Applied to U.S. data, they give a tight upper bound on the importance of monetary shocks for inflation dynamics.

Creation Date

2021-07

Section URL ID

Paper Number

2021-40

URL

https://scholar.princeton.edu/sites/default/files/decomp_iv.pdf

File Function

Jel

C32, C36

Keyword(s)

external instrument, impulse response function, invertibility, proxy variable, variance decomposition

Suppress

false

Series

13