Local Projections or VARs? A Primer for Macroeconomists

José Luis Montiel Olea, Mikkel Plagborg-Moller, Eric Qian and Christian Wolf

No 33871, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: What should applied macroeconomists know about local projection (LP) and vector autoregression (VAR) impulse response estimators? The two methods share the same estimand, but in finite samples lie on opposite ends of a bias-variance trade-off. While the low bias of LPs comes at a quite steep variance cost, this cost must be paid to achieve robust uncertainty assessments. Hence, when the goal is to convey what can be learned about dynamic causal effects from the data, VARs should only be used with long lag lengths, ensuring equivalence with LP. For LP estimation, we provide guidance on selection of lag length and controls, bias correction, and confidence interval construction.

JEL-codes: C22 C32 (search for similar items in EconPapers)
Date: 2025-05
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