Innovations Meet Narratives -Improving the Power-Credibility Trade-off in Macro

• Authors: Geert Mesters and Régis Barnichon.
• BSE Working Paper: 1475 | January 25
• Keywords: Monetary and Fiscal Policy , missing data , time series identification , narrative identification
• JEL codes: C14, C32, E32, E52
• Monetary and Fiscal Policy
• missing data
• time series identification
• narrative identification

In macro, instances of clear and indisputable exogenous variation are rare and researchers often face a difficult trade-off between credibility and efficiency. In this work, we introduce a new method -innovation-powered IV-, which allows to reduce the confidence intervals of a credible but low power identification scheme (e.g., a narrative instrument) by leveraging the high power of a possibly misspecified parametric identification assumption (e.g., a short run restriction). The method delivers large reductions in confidence intervals for the causal effects of monetary and fiscal policy, with gains of around 40 percent compared to state of the art narratively-identified estimates.