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Background Indicators

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  • Burkhard Raunig

    (Central Bank of Austria, Economic Studies Division, Otto-Wagner-Platz 3, 1090 Vienna, Austria
    The views expressed in this study do not necessarily reflect the official viewpoint of the Oesterreichische Nationalbank or of the Eurosystem.)

Abstract

It is customary to assume that an indicator of a latent variable is driven by the latent variable and some random noise. In contrast, a background indicator is also systematically influenced by variables outside the structural model of interest. Background indicators deserve attention because in empirical work they are difficult to distinguish from ordinary effect indicators. This paper assesses instrumental variable (IV) estimation of the effect of a latent variable in a linear model when a background indicator replaces the latent variable. It turns out that IV estimates are inconsistent in many important cases. In some cases, the estimates capture causal effects of the indicator rather than causal effects of the latent variable. A simulation experiment that considers the impact of economic uncertainty on aggregate consumption illustrates some of the results.

Suggested Citation

  • Burkhard Raunig, 2019. "Background Indicators," Econometrics, MDPI, vol. 7(2), pages 1-14, May.
    • Handle: RePEc:gam:jecnmx:v:7:y:2019:i:2:p:20-:d:231113
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    More about this item

    Keywords

    causal graph; latent variable; indicator variable; instrumental variable; financial development; stock market volatility;
    All these keywords.

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C26 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Instrumental Variables (IV) Estimation
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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