Monday, April 8, 2019

Identification via the ZLB and More

Sophocles Mavroeidis at Oxford has a very nice paper on using the nominal interest rate zero lower bound (ZLB) to identify VAR's.  Effectively, hitting the ZLB is a form of (endogenous) structural change that can be exploited for identification.  He has results showing whether/when one has point identification, set identification, or no identification. Really good stuff.

An interesting question is whether there may be SETS of bounds that may be hit. Suppose so, and suppose that we don't know whether/when they'll be hit, but we do know that if/when one bound is hit, all bounds are hit. An example might be nominal short rates in two countries with tightly-integrated money markets.

Now recall the literature on testing for multivariate structural change, which reveals large power increases in such situations (Bai, Lumsdaine and Stock). In Sophocles' case, it suggests the potential for greatly sharpened set ID.  Of course it all depends on the truth/relevance of my supposition...

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