Rational expectations and the Paradox of policy-relevant natural experiments

Gilles Chemla and Christopher A. Hennessy

Journal of Monetary Economics, 2020, vol. 114, issue C, 368-381

Abstract: Policy experiments using large microeconomic datasets have recently gained ground in macroeconomics. Imposing rational expectations, we examine robustness of evidence derived from ideal natural experiments applied to atomistic agents in dynamic settings. Paradoxically, once experimental evidence is viewed as sufficiently clean to use, it then becomes contaminated by ex post endogeneity: Measured responses depend upon priors and the objective function into which evidence is fed. Moreover, agents’ policy beliefs become endogenously correlated with their causal parameters, severely clouding inference, e.g. sign reversals and non-invertibility may obtain. Treatment-control differences are contaminated for non-quadratic adjustment costs. Constructively, we illustrate how inference can be corrected accounting for feedback and highlight factors mitigating contamination.

Keywords: Natural experiments; Rational expectations; Causality; Policy (search for similar items in EconPapers)
JEL-codes: E6 G18 G28 G38 H00 O2 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:moneco:v:114:y:2020:i:c:p:368-381

DOI: 10.1016/j.jmoneco.2019.05.002

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