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Title: Robust Policy Counterfactuals with an Application to Fiscal Unions

Citation Type: Miscellaneous

Publication Year: 2016

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Abstract: Counterfactuals in fully specified structural models are the leading paradigm for analyzing systematic policy changes because they are immune to Lucas Critique. However, such coun- terfactuals are less credible whenever they lack robustness to variations in primitives across models that are observationally equivalent and reasonable a-priori. In this paper, I propose a methodology to construct policy counterfactuals in a set of linear models of dynamic stochas- tic economies that are both observationally equivalent under the benchmark policy and have identical counterfactual equilibrium under the alternative policy. These counterfactuals are immune to Lucas critique and robust to variations in primitives across models within the set. Then, I apply the methodology to quantify how fiscal unions contribute to regional stabiliza- tion. I focus on models where the federal government redistributes resources via a transfer policy rule in order to smooth local shocks. This rule is a function of local variables. Using US state-level data, I construct a counterfactual US economy without the rule in place. This counterfactual is identical in many fiscal union models with rich features, such as nominal rigidities and asset market incompleteness. I find that, during the Great Recession, fiscal inte- gration significantly reduced cross-state employment differences by redistributing resources from well to poorly performing states. Finally, I discuss how the methodology can further be used to falsify a set of models, provided data before and after a policy change is available.

Url: https://economics.stanford.edu/sites/g/files/sbiybj9386/f/martin_beraja_jmp.pdf

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Authors: Beraja, Martin

Publisher: MIT and Princeton University

Data Collections: IPUMS USA

Topics: Other

Countries: United States