State-Dependent Local Projections

Goncalves, Silvia; Herrera, Ana María; Kilian, Lutz; Pesavento, Elena

doi:10.24149/wp2302

Working Paper

State-Dependent Local Projections

Abstract: Do state-dependent local projections asymptotically recover the population responses of macroeconomic aggregates to structural shocks? The answer to this question depends on how the state of the economy is determined and on the magnitude of the shocks. When the state is exogenous, the local projection estimator recovers the population response regardless of the shock size. When the state depends on macroeconomic shocks, as is common in empirical work, local projections only recover the conditional response to an infinitesimal shock, but not the responses to larger shocks of interest in many applications. Simulations suggest that fiscal multipliers may be off by as much as 40 percent.

Keywords: local projections; business cycle; state-dependence; impulse response; multiplier; nonlinear structural model; potential outcomes model;

JEL Classification: C22; C32; H20; C51; E32; E52; E60; E62;

https://doi.org/10.24149/wp2302