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April 12, 2005
Identification and Two-Stage Least Squares
Identification is required for parameter estimation to be possible. Two-stage least squares is a common method for estimating identified equations.
We have already discussed the covariance between the right-hand side endogenous variable P and the two structural equation error terms.
Tw--stage least squars (2SLS) plugs in reducted form equation predictions for endogenous right-hand side variables and then, in stage two, estimates a structural equation with "hatted" variables. This works because the hatted variables are not functions of the structural equation error terms.
2SLS is possible only if an equation is identified. Otherwide, there is exact collinearity in the second stage.
The excluded variables that identify an equation shifts equations other than the one that is being identified.
Is a simple IS-LM model identified? It depends on whether you think that monetary and fiscal policy set the money supply and deficit without any concern for Y. This assumption would fly in the face of often stated objectives of these policies.
Posted by bparke at April 12, 2005 07:47 PM