Equilibrium counterfactuals

Abstract

We incorporate structural modellers into the economy they model. Using traditional moment-matching, they treat policy changes as zero probability (or exogenous) ”counterfactuals.” Bias occurs since real-world agents understand policy changes are positive probability events guided by modellers. Downward, upward, or sign bias occurs. Bias is illustrated by calibrating the Leland model to the 2017 tax cut. The traditional identifying assumption, constant moment partial derivative sign, is incorrect with policy optimization. The correct assumption is constant moment total derivative sign accounting for estimation-policy feedback. Model agent expectations can be updated iteratively until policy advice converges to agent expectations, with bias vanishing.