Equilibrium Counterfactuals

Chemla, G and Hennessy, C (2021) Equilibrium Counterfactuals. International Economic Review, 62 (2). pp. 639-669. ISSN 0020-6598 OPEN ACCESS


We incorporate structural modelers into the economy they model. Using traditional moment matching, they treat policy changes as zero probability (or exogenous) “counterfactuals.” Bias occurs since real-world agents understand policy changes are positive probability events guided by modelers. Downward, upward, or sign bias occurs. Bias is illustrated by calibrating the Leland model to the 2017 tax cut. The traditional identifying assumption, constant moment partial derivative sign, is incorrect with policy optimization. The correct assumption is constant moment total derivative sign accounting for estimation-policy feedback. Model agent expectations can be updated iteratively until policy advice converges to agent expectations, with bias vanishing.

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Item Type: Article
Subject Areas: Finance
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© 2021 The Authors. International Economic Review published by Wiley Periodicals LLC on behalf of the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association. This is an open access article under the terms of the Creative Commons Attribution-Non-Commercial License, which permits use, distribution and reproduction in any medium, provided the original work is properly cited and is not used for commercial purposes.

Date Deposited: 25 Jan 2022 15:48
Date of first compliant deposit: 25 Jan 2022
Subjects: Market forecasting
Economic systems
Last Modified: 27 Jul 2023 00:40
URI: https://lbsresearch.london.edu/id/eprint/2213

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