Dynamic Effects of Persistent Shocks

TL;DR

This paper investigates the persistence of narrative shocks and how different estimation methods affect impulse response results, offering corrections to align local projections and distributed lag models for better empirical analysis.

Contribution

It introduces corrections to reconcile local projections and distributed lag models, improving the estimation of persistent shock effects in empirical research.

Findings

Persistence of narrative shocks is common.

Method choice significantly impacts dynamic effect estimates.

Proposed corrections improve estimation consistency.

Abstract

We provide evidence that many narrative shocks used by prominent literature are persistent. We show that the two leading methods to estimate impulse responses to an independently identified shock (local projections and distributed lag models) treat persistence differently, hence identifying different objects. We propose corrections to re-establish the equivalence between local projections and distributed lag models, providing applied researchers with methods and guidance to estimate their desired object of interest. We apply these methods to well-known empirical work and find that how persistence is treated has a sizable impact on the estimates of dynamic effects.