On the Properties of Various Estimators for Fiscal Reaction Functions, Issues 2006-2182
International Monetary Fund, Jul 1, 2006 - Business & Economics - 29 pages
This paper evaluates the bias of the least-squares-with-dummy-variables (LSDV) method in fiscal reaction function estimations. A growing number of studies estimate fiscal policy reaction functions-that is, relationships between the primary fiscal balance and its determinants, including public debt and the output gap. A previously unexplored methodological issue in these estimations is that lagged debt is not a strictly exogenous variable, which biases the LSDV estimator in short panels. We derive the bias analytically to understand its determinants and run Monte Carlo simulations to assess its likely size in empirical work. We find the bias to be smaller than the bias of the LSDV estimator in a comparable autoregressive dynamic panel model and show the LSDV method to outperform a number of alternatives in estimating fiscal reaction functions.
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Abiad Arellano and Bond asymptotic bias bias expression bias in estimating Bias S.E. Estimate Blundell and Bond Celasun countercyclical country dummies country-specific means Debrun debt dynamics debt in equation debt-dynamics equation denominator distributed lag dynamic panel data Emerging Market Countries endogenous regressors endogenous to contemporaneous Estimate Bias S.E. estimate fiscal reaction estimating equation estimation of equation expected biases fiscal policy fiscal reaction function Gali and Perotti GMM and SGMM GMM methods GMM SGMM SGMMR International Monetary Fund Kiviet lagged debt lagged dependent variable LSDV bias LSDV estimator LSDV GMM SGMM LSDV method LSDVIV matrix Monte Carlo simulations negative OLS and LSDV OLS estimator OLS LSDV GMM one-step system GMM Ostry output gap Panel Data Models plim primary balance shocks public debt reaction function model representation RMSE S.E. Estimate Bias samples satisfies the intertemporal scenario shocks to debt signal-to-noise ratio standard deviation system GMM estimator term vector