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Reducing large datasets to improve the identification of estimated policy rules

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  • Omer Bayar

    (Schroeder School of Business, University of Evansville)

Abstract

Monetary policy rules describe how policy interest rates respond to macroeconomic developments. These rules incorporate forward-looking models that require instruments for consistent estimation. The use of standard instruments leads to weak identification of forward-looking rules. We combine principal component analysis with hard thresholding to construct new instruments based on high-dimensional macro data. Component-based instruments enhance the identification of policy rules relative to standard results. The finding is attributed to specific variables in the data.

Suggested Citation

  • Omer Bayar, 2022. "Reducing large datasets to improve the identification of estimated policy rules," Empirical Economics, Springer, vol. 63(1), pages 113-140, July.
    • Handle: RePEc:spr:empeco:v:63:y:2022:i:1:d:10.1007_s00181-021-02134-z
    DOI: 10.1007/s00181-021-02134-z
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    More about this item

    Keywords

    Forward-looking rule; Instrument weakness; Robust estimation; Instrument abundance; Principal component analysis; Hard thresholding;
    All these keywords.

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • C26 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Instrumental Variables (IV) Estimation

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