Dynamic Effects of Persistent Shocks

59 Pages Posted: 26 Dec 2019

See all articles by Mario Alloza

Mario Alloza

Banco de España

Jesús Gonzalo

Universidad Carlos III de Madrid

Carlos Sanz

Banco de España

Date Written: December 23, 2019

Abstract

We show that several shocks identified without restrictions from a model, and frequently used in the empirical literature, display some persistence. We demonstrate that the two leading methods to recover impulse responses to shocks (moving average representations and local projections) treat persistence differently, hence identifying different objects. In particular, standard local projections identify responses that include an effect due to the persistence of the shock, while moving average representations implicitly account for it. We propose methods to re-establish the equivalence between local projections and moving average representations. In particular, the inclusion of leads of the shock in local projections allows to control for its persistence and renders the resulting responses equivalent to those associated to counterfactual non-serially correlated shocks. We apply this method to well-known empirical work on fiscal and monetary policy and find that accounting for persistence has a sizable impact on the estimates of dynamic effects.

Keywords: impulse response function, local projection, shock, fiscal policy, monetary policy

JEL Classification: C32, E32, E52, E62

Suggested Citation

Alloza, Mario and Gonzalo, Jesus and Sanz, Carlos, Dynamic Effects of Persistent Shocks (December 23, 2019). Banco de Espana Working Paper No. 1944 (2019), Available at SSRN: https://ssrn.com/abstract=3508672 or http://dx.doi.org/10.2139/ssrn.3508672

Mario Alloza (Contact Author)

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

Jesus Gonzalo

Universidad Carlos III de Madrid ( email )

E-28903 Getafe (Madrid)
Spain

Carlos Sanz

Banco de España ( email )

Alcala 50
Madrid 28014
Spain

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