Specification Choice in Local Projections: Evidence from Monetary Policy Shocks

This study examines how specification choices in local projections influence the estimation of impulse responses to monetary policy shocks. Using monthly U.S. data from 1983 to 2007 and the Aruoba and Drechsel (2024) shock series, I systematically compare levels and long-differences specifications across 12 control sets and multiple lag lengths. The results are evaluated both qualitatively by benchmarking impulse responses against theory, standard beliefs, and prior evidence and quantitatively, using information criteria (AIC, BIC, CV). The findings show that the long-differences specification produces distorted long-term dynamics. In contrast, the levels specification, when paired with a robust control set, generates well-behaved responses. These results stress the importance of careful specification and provide practical guidance for researchers applying local projections to monetary policy shocks.