- Email: [email protected]
Rejoinder to Hendry
Carnegie-RochesterConferenceSeries on Public Policy47 (1997) 191-195 North-Holland
Rejoinder to Hendry Jon Faust Board of Governors, Federal Reserve System and C h a r l e s H. W h i t e m a n The University of Iowa
If one read Professor Hendry's response to our paper before the paper itself, one might suspect that we had been quite critical of the LSE approach. Thus, we begin by reiterating that the LSE approach has been widely used, achieved notable successes, and, along with other popular methods, deserves a great deal of attention from anyone shopping for good ways to analyze macroeconomic data. We would like to see a hybrid approach drawing on the strengths of several approaches-the LSE, VAR, and RBC approaches as well as Bayesian and Leameresque approaches. Elements of the LSE approach such as the emphasis on checking maintained assumptions seem like important components of such a hybrid.
1
R e v i e w , clarification, c o r r e c t i o n
Beside providing an entry point into the LSE approach for those not familiar with its jargon, the most important elements of our paper were two criticisms. Briefly, 1. The approach's emphasis on using tests to tailor the empirical specification to the available sample need not be optimal. . In absence of a priori assumptions excluding the breaks from the equation of interest, the LSE breaks-based identification technique provides no basis for placing economically meaningful labels like "money demand' or "money supply" on any estimated equation. The basis for these criticisms is well-established in the literature. In the second criticism, we mean nothing more than Koopmans meant in the passage quoted in our conclusion, and, more importantly, we mean nothing more than what Engle and Hendry (1993) wrote in the passage we quoted. Notable in 0167-2231/97/$17.00/© 1997 - Elsevier ScienceB.V. All rights reserved. PII: S0167-2231(98)00009~8
Hendry's response is the lack of any alternative account of that passage. Moreover, both criticisms are founded at least in part on formal proofs. As noted in our paper, the first criticism has for simple cases been shown analytically; the second is purely analytic. Nothing in Hendry's response or in the other writings of the LSE school overturns this conventional analysis. Given limited space, we made the difficult decision not to take up Hendry's "Theory of Reduction." This is a theory related to the statistical theory of the same name (e.g., Lehmann, 1986) that regards, for example, sufficient statistics. Our charge was to analyze policy analysis in the LSE method; thus, while reduction theory provides motivation for the dictates that guide applied practice, we chose to focus on the dictates themselves. We recommend Hendry (1995, ch. 9) to the interested reader. We thank Hendry for pointing out the missing references in our literature search. The published text has been fixed.
2
Hendry's response
We now take up several of Professor Hendry's criticisms. [Faust and Whiteman's start...stop characterization of the RBC and VAR schools] crucially ignores the later reformulation and reapplieation of those approaches to essentially the same data... Their implicit attitude that only a single "one-off' study occurs is a travesty... Hendry does not explain why he imagines us to be making such a naive mistake. While our "start...stop" rules are an obvious caricature, they capture essential differences among the approaches-differences that are m o r e dramatic when viewing the literatures as a whole than when viewing individual papers. The most casual observer would recognize that, for example, every LSE-style paper reports extensive theory-free tailoring of the model that overwhelms any such alterations made in the RBC literature as a whole. Hendry calls our exposition of weak exogeneity "fiction," and likens its authors to something fowl in the weeds. We find three claims supporting this view. First, Hendry disagrees with our statement that weak exogeneity is necessary for efficient conditional inference, stating that the concept has no "generic implications for 'estimation methods,' or 'estimation efficiency'." This is wrong: generically, if weak exogeneity fails, then e v e r y conditional estimate ignores useful information and, cannot, thereby, be efficient. Second, Hendry suggests that we confound "the existence of parametric dependence...with the imposition (or not) of the resulting restrictions." We argue that the weak exogeneity dictate mandates "exploiting" in some way all cross-equation restrictions. This is correct. The weak exogeneity dictate 192
mandates abandoning conditional estimators for system estimators whenever there are cross-equation restrictions. The system methods will exploit the extra information in some way. 1 Third, Hendry suggests that we are confused about simultaneity and "corrects" us by saying that "existence of simultaneity does n o t preclude weak exogeneity...." We make no claim to the contrary. Regarding identification, Hendry seems to think that in raising critique (2), we care primarily about whether the LSE breaks approach is sufficient to pick a unique representation of the reduced form. It follows trivially from the fact that LSE'ers produce point estimates that they have chosen a particular representation of the portion of the system reported. We hope that it is clear in the paper that we are interested in whether there are sufficient economically justified assumptions so that the equations "deserve an economically meaningful title like money demand or money supply." Since our discussion of LSE identification focused exclusively on breaks identification, and since we noted explicitly that some LSE work rests on conventional identification schemes, we are surprised that Hendry accuses us of "ignoring" LSE models identified by conditioning. We note (Footnote 13) that one might view the breaks identification scheme as attaining just-identified status by conditioning, in which case our critique should be interpreted as showing that the breaks scheme provides no over-identifying restrictions. Identifying, say, money demand by conditioning assumptions amounts to assuming that money demand is alone in the final block of a blockrecursive ordering of the economy. This is a variant of the Wold causal chain or Cholesky factorization popularized by Sims (1980). Generally thought to be economically implausible, this scheme has been abandoned in the VAR literature in favor of a search for more economically plausible assumptions (e.g., Leeper, Sims, and Zha, 1996). The economic rationale for the conditioning argument in the LSE literature is unclear. Hendry imagines that he will surprise us with the fact that "the form of the model which they so dislike, and claim to be useless for policy, is in fact used by most European policy agencies .... " We do not criticize the general "form" of any LSE equation, or the error-correction form, in particular. We discuss two equations of the LSE form, calling o n e ~ U . K , money d e m a n d - an "impressive victory for the approach," while criticizing the other--U.S. money demand. Further, we do not call the LSE money-demand equations "useless for policy," rather, we correctly point out that they must be embedded in more complete models to answer most policy questions. The myriad agencies listed have presumably done so. IThis ignores the absurd possibility that while the LSE'ers regard conditional estimators as not "valid" when weak exogeneity fails, they do regard as valid estimators that do not exploit in any way the information that led to the failure of weak exogeneity. 193
Hendry asks, "[D]oes he [Faust] really claim that the [Fed's large econometric] model has not been substantially influenced by the 'LSE' approach?" Quite obviously not. We clearly state that the LSE, RBC, and VAR approaches are widely used. This is true at the Fed as it is elsewhere. While the Fed staff has embraced elements of the LSE approach such as those applauded in our paper, the Fed has not, in our view, embraced the elements of the LSE approach we criticize. Indeed our critique of the U.S. moneydemand equation is based almost exclusively on work done at the Fed (Hess, Jones, and Porter, 1997). Hendry also takes us to task for our rhetoric. Suppressing an overwhelming sense of irony, we once again turn to the support offered. For one example, we say that the LSE approach has until recently emphasized "single-equation work," while Hendry would prefer us to say that the LSE "sought to isolate problems in the simplest context of one equation." For another example, LSE breaks-identification requires that one verify instability of equations for the right-hand side variables in the equation of interest. Hendry dislikes that we say that that the specification may be "cursory," whereas LSE'ers prefer to emphasize that the specification may be "simple" (Ahumada, 1992, p. 349). We are no longer surprised at the lack of discourse among the econometric camps. We could continue in this manner far longer than the editor would allow or any reader could profitably endure. Hendry perceives in our work travesties, claims that his approach is "useless," unfair use of terms like "single-equation," and a cover-up of the use of LSE methods at the Fed. The list goes on. We believe that we have provided a balanced description and critique of the LSE approach.
194
References
Ahumada, H., (1992). A Dynamic Model of the Demand for Currency: Argentina 1977-1988, Journal of Policy Modeling, 14: 335-362. Lehmann, E.L., (1986). Testing Statistical Hypotheses. New York, Wiley and Sons.
195
Rejoinder to Hendry Jon Faust Board of Governors, Federal Reserve System and C h a r l e s H. W h i t e m a n The University of Iowa
If one read Professor Hendry's response to our paper before the paper itself, one might suspect that we had been quite critical of the LSE approach. Thus, we begin by reiterating that the LSE approach has been widely used, achieved notable successes, and, along with other popular methods, deserves a great deal of attention from anyone shopping for good ways to analyze macroeconomic data. We would like to see a hybrid approach drawing on the strengths of several approaches-the LSE, VAR, and RBC approaches as well as Bayesian and Leameresque approaches. Elements of the LSE approach such as the emphasis on checking maintained assumptions seem like important components of such a hybrid.
1
R e v i e w , clarification, c o r r e c t i o n
Beside providing an entry point into the LSE approach for those not familiar with its jargon, the most important elements of our paper were two criticisms. Briefly, 1. The approach's emphasis on using tests to tailor the empirical specification to the available sample need not be optimal. . In absence of a priori assumptions excluding the breaks from the equation of interest, the LSE breaks-based identification technique provides no basis for placing economically meaningful labels like "money demand' or "money supply" on any estimated equation. The basis for these criticisms is well-established in the literature. In the second criticism, we mean nothing more than Koopmans meant in the passage quoted in our conclusion, and, more importantly, we mean nothing more than what Engle and Hendry (1993) wrote in the passage we quoted. Notable in 0167-2231/97/$17.00/© 1997 - Elsevier ScienceB.V. All rights reserved. PII: S0167-2231(98)00009~8
Hendry's response is the lack of any alternative account of that passage. Moreover, both criticisms are founded at least in part on formal proofs. As noted in our paper, the first criticism has for simple cases been shown analytically; the second is purely analytic. Nothing in Hendry's response or in the other writings of the LSE school overturns this conventional analysis. Given limited space, we made the difficult decision not to take up Hendry's "Theory of Reduction." This is a theory related to the statistical theory of the same name (e.g., Lehmann, 1986) that regards, for example, sufficient statistics. Our charge was to analyze policy analysis in the LSE method; thus, while reduction theory provides motivation for the dictates that guide applied practice, we chose to focus on the dictates themselves. We recommend Hendry (1995, ch. 9) to the interested reader. We thank Hendry for pointing out the missing references in our literature search. The published text has been fixed.
2
Hendry's response
We now take up several of Professor Hendry's criticisms. [Faust and Whiteman's start...stop characterization of the RBC and VAR schools] crucially ignores the later reformulation and reapplieation of those approaches to essentially the same data... Their implicit attitude that only a single "one-off' study occurs is a travesty... Hendry does not explain why he imagines us to be making such a naive mistake. While our "start...stop" rules are an obvious caricature, they capture essential differences among the approaches-differences that are m o r e dramatic when viewing the literatures as a whole than when viewing individual papers. The most casual observer would recognize that, for example, every LSE-style paper reports extensive theory-free tailoring of the model that overwhelms any such alterations made in the RBC literature as a whole. Hendry calls our exposition of weak exogeneity "fiction," and likens its authors to something fowl in the weeds. We find three claims supporting this view. First, Hendry disagrees with our statement that weak exogeneity is necessary for efficient conditional inference, stating that the concept has no "generic implications for 'estimation methods,' or 'estimation efficiency'." This is wrong: generically, if weak exogeneity fails, then e v e r y conditional estimate ignores useful information and, cannot, thereby, be efficient. Second, Hendry suggests that we confound "the existence of parametric dependence...with the imposition (or not) of the resulting restrictions." We argue that the weak exogeneity dictate mandates "exploiting" in some way all cross-equation restrictions. This is correct. The weak exogeneity dictate 192
mandates abandoning conditional estimators for system estimators whenever there are cross-equation restrictions. The system methods will exploit the extra information in some way. 1 Third, Hendry suggests that we are confused about simultaneity and "corrects" us by saying that "existence of simultaneity does n o t preclude weak exogeneity...." We make no claim to the contrary. Regarding identification, Hendry seems to think that in raising critique (2), we care primarily about whether the LSE breaks approach is sufficient to pick a unique representation of the reduced form. It follows trivially from the fact that LSE'ers produce point estimates that they have chosen a particular representation of the portion of the system reported. We hope that it is clear in the paper that we are interested in whether there are sufficient economically justified assumptions so that the equations "deserve an economically meaningful title like money demand or money supply." Since our discussion of LSE identification focused exclusively on breaks identification, and since we noted explicitly that some LSE work rests on conventional identification schemes, we are surprised that Hendry accuses us of "ignoring" LSE models identified by conditioning. We note (Footnote 13) that one might view the breaks identification scheme as attaining just-identified status by conditioning, in which case our critique should be interpreted as showing that the breaks scheme provides no over-identifying restrictions. Identifying, say, money demand by conditioning assumptions amounts to assuming that money demand is alone in the final block of a blockrecursive ordering of the economy. This is a variant of the Wold causal chain or Cholesky factorization popularized by Sims (1980). Generally thought to be economically implausible, this scheme has been abandoned in the VAR literature in favor of a search for more economically plausible assumptions (e.g., Leeper, Sims, and Zha, 1996). The economic rationale for the conditioning argument in the LSE literature is unclear. Hendry imagines that he will surprise us with the fact that "the form of the model which they so dislike, and claim to be useless for policy, is in fact used by most European policy agencies .... " We do not criticize the general "form" of any LSE equation, or the error-correction form, in particular. We discuss two equations of the LSE form, calling o n e ~ U . K , money d e m a n d - an "impressive victory for the approach," while criticizing the other--U.S. money demand. Further, we do not call the LSE money-demand equations "useless for policy," rather, we correctly point out that they must be embedded in more complete models to answer most policy questions. The myriad agencies listed have presumably done so. IThis ignores the absurd possibility that while the LSE'ers regard conditional estimators as not "valid" when weak exogeneity fails, they do regard as valid estimators that do not exploit in any way the information that led to the failure of weak exogeneity. 193
Hendry asks, "[D]oes he [Faust] really claim that the [Fed's large econometric] model has not been substantially influenced by the 'LSE' approach?" Quite obviously not. We clearly state that the LSE, RBC, and VAR approaches are widely used. This is true at the Fed as it is elsewhere. While the Fed staff has embraced elements of the LSE approach such as those applauded in our paper, the Fed has not, in our view, embraced the elements of the LSE approach we criticize. Indeed our critique of the U.S. moneydemand equation is based almost exclusively on work done at the Fed (Hess, Jones, and Porter, 1997). Hendry also takes us to task for our rhetoric. Suppressing an overwhelming sense of irony, we once again turn to the support offered. For one example, we say that the LSE approach has until recently emphasized "single-equation work," while Hendry would prefer us to say that the LSE "sought to isolate problems in the simplest context of one equation." For another example, LSE breaks-identification requires that one verify instability of equations for the right-hand side variables in the equation of interest. Hendry dislikes that we say that that the specification may be "cursory," whereas LSE'ers prefer to emphasize that the specification may be "simple" (Ahumada, 1992, p. 349). We are no longer surprised at the lack of discourse among the econometric camps. We could continue in this manner far longer than the editor would allow or any reader could profitably endure. Hendry perceives in our work travesties, claims that his approach is "useless," unfair use of terms like "single-equation," and a cover-up of the use of LSE methods at the Fed. The list goes on. We believe that we have provided a balanced description and critique of the LSE approach.
194
References
Ahumada, H., (1992). A Dynamic Model of the Demand for Currency: Argentina 1977-1988, Journal of Policy Modeling, 14: 335-362. Lehmann, E.L., (1986). Testing Statistical Hypotheses. New York, Wiley and Sons.
195