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Local Projections or VARs? A Primer for Macroeconomists

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  • Jos'e Luis Montiel Olea
  • Mikkel Plagborg-M{o}ller
  • Eric Qian
  • Christian K. Wolf

Abstract

What should applied macroeconomists know about local projection (LP) and vector autoregression (VAR) impulse response estimators? The two methods share the same estimand, but in finite samples lie on opposite ends of a bias-variance trade-off. While the low bias of LPs comes at a quite steep variance cost, this cost must be paid to achieve robust uncertainty assessments. VARs should thus only be used with long lag lengths, ensuring equivalence with LP. For LP estimation, we provide guidance on selection of lag length and controls, bias correction, and confidence interval construction.

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  • Jos'e Luis Montiel Olea & Mikkel Plagborg-M{o}ller & Eric Qian & Christian K. Wolf, 2025. "Local Projections or VARs? A Primer for Macroeconomists," Papers 2503.17144, arXiv.org.
    • Handle: RePEc:arx:papers:2503.17144
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