Reducing large datasets to improve the identification of estimated policy rules

Omer Bayar ()
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Omer Bayar: Schroeder School of Business, University of Evansville

Empirical Economics, 2022, vol. 63, issue 1, No 4, 113-140

Abstract: Abstract Monetary policy rules describe how policy interest rates respond to macroeconomic developments. These rules incorporate forward-looking models that require instruments for consistent estimation. The use of standard instruments leads to weak identification of forward-looking rules. We combine principal component analysis with hard thresholding to construct new instruments based on high-dimensional macro data. Component-based instruments enhance the identification of policy rules relative to standard results. The finding is attributed to specific variables in the data.

Keywords: Forward-looking rule; Instrument weakness; Robust estimation; Instrument abundance; Principal component analysis; Hard thresholding (search for similar items in EconPapers)
JEL-codes: C26 E52 E58 (search for similar items in EconPapers)
Date: 2022
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DOI: 10.1007/s00181-021-02134-z

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