Lecture Notes The narrative approach to establishing causation in

macroeconomics (Christina D. Romer – Keynes Lecture)

 Dfn: empirical technique where sb gathers systematic evidence from contemporary

qualitative sources (newspapers, government reports, policy meeting transcripts) and
incorporates it into statistical analysis
 Issues:
1. What are the strengths and weaknesses of the narrative approach
2. What is required to make narrative work scientifically rigorous and replicable?
3. How does it compare with other approaches?
 Does monetary policy matter? Yes it does!
 Consider regressing output (or unemployment) on changes in the policy interest rate
 It matters why the central bank is changing interest rates
 If countercyclical or anticipatory movements in interest rates are common, the
coefficient on interest rates will be biased towards 0 (a large fraction of monetary
policy is geared towards offsetting factors caused by other powers
 Policy makers may misjudge the importance of their actions
 Omitted variable bias is a ubiquitous problem in macroeconomics. Two other examples:
 The real effects of financial crises
 Causal relationship between the impact of government austerity programs and the
economy
 Two steps in the narrative approach
1. Gather systematic evidence from qualitative sources (narrative analysis)
2. Incorporate it into a statistical framework for hypothesis testing
 Requirements for Strong Narrative Analysis
1. A consistent, contemporary, accurate narrative source
2. A clear idea of what one is looking for in the documents
3. Approach the source honestly and consistently
 Our narrative source
 Detailed minutes and verbatim transcripts of Federal Reserve monetary policy meetings
 For most of our sample, these records were expected to remain confidential
 Criteria for a monetary policy shock
 Contractionary: Policymakers chose to raise interest rates because they wanted to
lower inflation, and were willing to accept adverse consequences for output and
unemployment
 Expansionary: Policymakers chose to lower interest rates because they wanted to
lower unemployment, and were willing to accept adverse consequences for inflation
 Contractionary Shock in December 1988
“I think the job before us is to contain inflation and to slow this economy down. Now, the
danger is that I don’t think we have the time to do that…”
 Expansionary a Shock in January 1972
“The committee should consider whether stimulating the economy to greater heights in the
short run would not involve a cost in the form of a resurgence of inflationary pressures later
on”
 From 1940 to 2000, there have been 8 contractionary measures taken, recorded by the
Federal Reserve and 4 expansionary measures
 Define a monetary shock dummy variable
 1 in a month when there is a contractionary shock
  -1 in a month when there is an expansionary shock
 0 otherwise
 We can scale our dummy variable to measure the extent of the contractionary or
expansionary policy
 Contractionary shocks are more contractionary than expansionary shocks are expansionary
(effects of expansionary shocks wane out more quickly)
 Monetary policy was a very important factor of recessions (USA) in the first 50 decades of
post-ww2 period
 Contribution of monetary shocks to recessions
 Shocks account for more than 31% of USA’s recessions
 Other approaches to estimating the effects of monetary policy
1. Vector auto-regressions (VARs)
2. Residuals from a reaction function estimated on central bank forecasts
3. High-frequency identification
 Some other topics where the narrative approach could be useful
1. Institutions and economic growth
2. Financial structure or regulation and financial stability
 Is there an easier way to use the narrative approach? (More scientific and rigorous but less
time consuming?)
 When are you able to delegate the narrative work to an untrained human or a computer?
 Machine Learning and Narrative Research
 Training is essential
 Even then, cases with limited numbers of observations or complex categorization
may not feasibly be delegated to a computer