A0154
Title: Identifying impulse responses with instrumental variables
Authors: Myung Hwan Seo - Seoul National University (Korea, South) [presenting]
Bonsoo Koo - Monash University (Australia)
Seojeong Jay Lee - Seoul National University (Korea, South)
Abstract: Macro shocks are often composites, yet their implications are overlooked in impulse response analysis. When an instrumental variable (IV) is used to identify a composite shock, it violates the common IV exclusion restriction. It is shown that the local projection-IV estimand is represented as a weighted average of component-wise impulse responses, but with possibly negative weights, which occur when the IV and shock components have opposite signs of correlation. An LP-IV estimand with negative weights does not have a causal interpretation. However, when combined appropriately with other LP-IV estimands, such a non-causal LP-IV estimand can provide identification of the component-wise impulse responses. Identification strategies are developed based on additional granular information or sign restrictions. In contrast, conventional approaches combining multiple instruments, such as two-stage least squares, do not provide identification of structural parameters. Applications confirm the composite nature of monetary policy shocks and reveal a non-defense spending multiplier exceeding one.
