Testing Macro Models for Policy Use - An Insurrection in Applied Modelling

14 Pages Posted: 5 Aug 2016

See all articles by Patrick Minford

Patrick Minford

Cardiff University Business School; Centre for Economic Policy Research (CEPR)

Date Written: September 2016

Abstract

I describe a new departure in classical testing methods based on Indirect Inference. I argue that it gives policymakers, anxious to know if their models give reliable policy conclusions, a way to find out. I discuss how using Monte Carlo experiments my co‐authors and I have found that in the small samples typically available in macroeconomic modelling, the Indirect Inference Wald, IIW, test has considerably more power than the popular direct inference test using the Likelihood Ratio, LR. This is both because the LR is applied after re‐estimation of the model error processes and because the IIW test uses the false model's own restricted distribution for the auxiliary model's coefficients. This greater power allows users to focus this test more narrowly on features of interest, trading off power against tractability. If they can find a model version that is not rejected by the test, they can then discover the robustness of their model results to the parameter variations that might also have passed the test.

Suggested Citation

Minford, Patrick, Testing Macro Models for Policy Use - An Insurrection in Applied Modelling (September 2016). The Manchester School, Vol. 84, Issue S1, pp. 42-55, 2016. Available at SSRN: https://ssrn.com/abstract=2818781 or http://dx.doi.org/10.1111/manc.12164

Patrick Minford (Contact Author)

Cardiff University Business School ( email )

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Centre for Economic Policy Research (CEPR)

London
United Kingdom

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