Perhaps the most interesting and productive use of estimated KK systems is in ‘counter-factual’ analysis. Counter-factual analysis deals with questions of the ‘what if variety’. In KK counter-factual analysis the ‘what if questions addressed are usually of three broad types. The first are questions of the form: What if the macro economy were to be subjected to a particular pattern of exogenous change at some specific point of time, or over some specific interval of time in the future? Examples of questions which could be cast in this form are the following: How would the macro economy respond if a 5 per cent tax surcharge were to be imposed in three months’ time? What would happen to output, employment and the inflation rate if the price of imported oil were to rise by 25 per cent over the next twelve months? When called on to examine questions of this type, counter-factual analysis is often referred to as conditional forecasting to convey the idea that in this area of counter-factual analysis we are concerned with the implications for the future of a purely hypothetical pattern of exogenous change.
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References and further reading
- Lucas, Robert E. Jr. (1976) ‘Econometric Policy Evaluation: A Critique’, in K. Brunner and A. H. Meitzer (eds), The Phillips Curve and Labour Markets, North-Holland, Amsterdam.Google Scholar