Tests of Policy Ine¤ectiveness in Macroeconometrics

This paper proposes tests of policy ine¤ectiveness in the context of macroeconometric rational expectations models. It is assumed that there is a policy intervention that takes the form of changes in the parameters of a policy rule, and that there are su¢ cient observations before and after the intervention. The test is based on the di¤erence between the realisations of the outcome variable of interest and counterfactuals based on no policy intervention, using only the pre-intervention parameter estimates, and in consequence the Lucas Critique does not apply. The paper develops tests of policy ine¤ectiveness for a full structural model, with and without exogenous, policy or non-policy, variables. Asymptotic distributions of the proposed tests are derived both when the post intervention sample is …xed as the pre-intervention sample expands, and when both samples rise jointly but at di¤erent rates. The performance of the test is illustrated by a simulated policy analysis of a three equation New Keynesian Model, which shows that the test size is correct but the power may be low unless the model includes exogenous variables, or if the policy intervention changes the steady states, such as the in‡ation target. Keywords: Counterfactuals, policy analysis, policy ine¤ectiveness test, macroeconomics JEL classi…cation: C18, C54, E65, We are grateful to Karrar Hussain and Alex Chudik for their help with the calibration and simulation exercises reported in the paper. We have also bene…ted from discussions with Oscar Jorda, Adrian Pagan, Ivan Petrella and Glenn Rudebusch.