Series: Working Papers. 1944.
Author: Mario Alloza, Jesús Gonzalo and Carlos Sanz.
Published in: Journal of Applied Econometrics, online (February 2025)
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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.