This week’s homework is based on Fuchs-Schündeln and Hassan (2015) available here: http://www.hoover.org/sites/default/files/fuschs-schundeln-hassan-papernaturalexperimentsmacro_mar16.pdf.

Read the paper up until the end of the fiscal policy section (do not read the part on the determinants of economic growth). Then answer the following (strong hint: all of this material is examinable):

  1. Draw a causal diagram, as in class. Include an outcome variable, a treatment variable, an observed confounding variable (control variable), an unobserved confounding variable, an instrumental variable, and a bad control variable.
  2. If I want to estimate the (linear) causal relationship between the treatment variable and outcome variable under the assumption that there are no unobserved confounders, what linear regression model should I estimate?
  3. Suppose I am concerned that there are unobserved confounders that affect both the treatement and the outcome, and as such I cannot assume that the relationship between them is causal. How should I go about identifying the causal effect?
  4. Describe the two properties that an instrumental variable must have. What is the exclusion restriction? What is the relationship between an instrumental variable and a natural experiment?
  5. Divide the following between your teammates (put a name next to each submission, one paper each): describe two natural experiments that researchers have used to examine the permanent income hypothesis and two natural experiments used to examine the fiscal multiplier. You may need to read the original papers. What data do they use? What is the natural experiment? What are their exclusion restrictions? Do you believe their exclusion restrictions? What are their findings?