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Counterfactual analysis in macroeconometrics: An empirical investigation into the effects of quantitative easing

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  • Hashem Pesaran, M.
  • Smith, Ron P.

Abstract

This paper develops tests of policy ineffectiveness when counterfactual outcomes, namely the predicted values of the target variable in the absence of a policy change, are obtained using reduced form or final form ‘policy response equations’. The policy response equation explains the target variable by lags of itself and by current and lagged values of the policy variable and policy-invariant exogenous variables. These tests complement those in Pesaran and Smith (2015), which are done in the context of complete systems of macroeconometric dynamic stochastic general equilibrium (DSGE) under rational expectations (RE). While there would be efficiency gains from using the complete system, were it fully known and correctly specified, this is rarely the case. Instead, since the counterfactual is a type of forecast and parsimonious models tend to forecast better than complex ones, we may obtain more reliable estimates of the counterfactual outcomes from a parsimonious policy response equation. We consider two types of policy intervention, a discretionary policy change where there is a deterministic change to the policy variable, and a rule-based policy change where one or more parameters of a stochastic policy rule are changed. We examine the asymptotic distributions and power of the tests under various assumptions. The proposed test for a discretionary policy change is illustrated with an application to the unconventional monetary policy known as quantitative easing (QE) adopted in the UK.

Suggested Citation

  • Hashem Pesaran, M. & Smith, Ron P., 2016. "Counterfactual analysis in macroeconometrics: An empirical investigation into the effects of quantitative easing," Research in Economics, Elsevier, vol. 70(2), pages 262-280.
  • Handle: RePEc:eee:reecon:v:70:y:2016:i:2:p:262-280
    DOI: 10.1016/j.rie.2016.01.004
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    2. Vincenzo Bove & Roberto Nisticò, 2014. "Coups d’état and defense spending: a counterfactual analysis," Public Choice, Springer, vol. 161(3), pages 321-344, December.
    3. Belke, Angar & Gros, Daniel & Osowski, Thomas, 2017. "The effectiveness of the Fed’s quantitative easing policy: New evidence based on international interest rate differentials," Journal of International Money and Finance, Elsevier, vol. 73(PB), pages 335-349.
    4. Belke, Ansgar & Gros, Daniel & Osowski, Thomas, 2016. "Did quantitative easing affect interest rates outside the US? New evidence based on interest rate differentials," CEPS Papers 11266, Centre for European Policy Studies.
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    7. Chen, Qianying & Filardo, Andrew & He, Dong & Zhu, Feng, 2016. "Financial crisis, US unconventional monetary policy and international spillovers," Journal of International Money and Finance, Elsevier, vol. 67(C), pages 62-81.
    8. Renzo Rossini & Adrián Armas & Zenón Quispe, 2014. "Global policy spillovers and Peru’s monetary policy: inflation targeting, foreign exchange intervention and reserve requirements," BIS Papers chapters,in: Bank for International Settlements (ed.), The transmission of unconventional monetary policy to the emerging markets, volume 78, pages 241-264 Bank for International Settlements.
    9. Pesaran, M. Hashem & Smith, Ron P., 2014. "Signs of impact effects in time series regression models," Economics Letters, Elsevier, vol. 122(2), pages 150-153.
    10. Joyce, Michael & Spaltro, Marco, 2014. "Quantitative easing and bank lending: a panel data approach," Bank of England working papers 504, Bank of England.
    11. Povilas Lastauskas & Julius Stakënas, 2016. "Openness and Structural Labour Market Reforms: Counterfactuals for Lithuania," Bank of Lithuania Discussion Paper Series 1, Bank of Lithuania.
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    15. Li MA & Zhongyuan DUAN & Huadan YU, 2013. "The Transmission Mechanism and Effectiveness of the Fed's Operation Twist," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(3), pages 164-181, October.
    16. Marco Vega & Adrian Armas & Paul Castillo, 2014. "Inflation Targeting and Quantitative Tightening: Effects of Reserve Requirements in Peru," ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, ECONOMIA JOURNAL OF THE LATIN AMERICAN AND CARIBBEAN ECONOMIC ASSOCIATION, vol. 0(Fall 2014), pages 133-175, June.
    17. Harrison, Richard, 2017. "Optimal quantitative easing," Bank of England working papers 678, Bank of England.
    18. Barroso, João Barata R.B. & da Silva, Luiz A. Pereira & Sales, Adriana Soares, 2016. "Quantitative easing and related capital flows into Brazil: Measuring its effects and transmission channels through a rigorous counterfactual evaluation," Journal of International Money and Finance, Elsevier, vol. 67(C), pages 102-122.
    19. Lim, Jamus Jerome & Mohapatra, Sanket, 2016. "Quantitative easing and the post-crisis surge in financial flows to developing countries," Journal of International Money and Finance, Elsevier, vol. 68(C), pages 331-357.
    20. Claudio Borio & Anna Zabai, 2016. "Unconventional monetary policies: a re-appraisal," BIS Working Papers 570, Bank for International Settlements.
    21. M Hashem Pesaran & Ron P Smith, 2017. "Tests of Policy Interventions in DSGE Models," BCAM Working Papers 1706, Birkbeck Centre for Applied Macroeconomics.
    22. Carrera, César & Pérez-Forero, Fernando & Ramírez-Rondán, Nelson, 2014. "Effects of the U.S. quantitative easing on the Peruvian economy," Working Papers 2014-017, Banco Central de Reserva del Perú.
    23. Nikolay Hristov & Oliver Hülsewig & Timo Wollmershäuser, 2018. "Capital Flows in the Euro Area and TARGET2 Balances," CESifo Working Paper Series 6877, CESifo Group Munich.
    24. Salvatore Morelli, 2014. "Banking Crises in the US: the Response of Top Income Shares in a Historical Perspective," CSEF Working Papers 359, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
    25. Cafora, Alfonso & Romano, Antonio Angelo & Ronghi, Monica & Giuseppe, Scandurra, 2017. "Substituting fossil energy sources: the role of the climate funds and effects on the economic growth," MPRA Paper 82373, University Library of Munich, Germany.

    More about this item

    Keywords

    Counterfactuals; Policy analysis; Policy ineffectiveness test; Macroeconomics; Quantitative easing (QE);

    JEL classification:

    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General
    • C54 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Quantitative Policy Modeling
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes

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