CEA Policy Evaluation & Economic Forecasting 4 — Questions and Answers
Question 1: When evaluating a minimum wage increase, a 'bunching estimator' identifies the effect by examining:
- The aggregate change in total payroll costs
- Excess mass in the wage distribution at the new minimum (Correct answer)
- Regression discontinuity at eligibility thresholds
- Difference-in-differences across industries
Correct answer: Excess mass in the wage distribution at the new minimum
Bunching estimators exploit the spike in the wage distribution exactly at the minimum wage to infer the employment and wage effects of the policy.
Question 2: The Taylor Rule provides a framework for setting:
- Fiscal spending targets based on the output gap
- Optimal income tax rates given inflation
- The federal funds rate based on inflation and output gap deviations (Correct answer)
- Exchange rate targets for monetary policy
Correct answer: The federal funds rate based on inflation and output gap deviations
The Taylor Rule prescribes an interest rate that responds to deviations of inflation from target and output from potential, guiding central bank decisions.
Question 3: An economic analyst uses a DSGE model. What distinguishes it from a purely statistical model?
- It relies only on historical data patterns
- It is grounded in microeconomic theory about agent optimization and market clearing (Correct answer)
- It cannot be used for policy simulation
- It excludes monetary policy variables
Correct answer: It is grounded in microeconomic theory about agent optimization and market clearing
DSGE models derive dynamics from explicit optimization by households, firms, and policymakers, making them theoretically consistent and useful for structural policy analysis.
Question 4: The 'Lucas critique' warns policy evaluators that:
- Historical data becomes irrelevant once prices change
- Estimated behavioral relationships break down when policy changes, because agents adjust expectations (Correct answer)
- GDP forecasts are inherently inaccurate beyond one year
- Fiscal multipliers always exceed monetary multipliers
Correct answer: Estimated behavioral relationships break down when policy changes, because agents adjust expectations
Lucas argued that using historical reduced-form relationships to simulate policy is flawed because private sector expectations—and thus behavior—change in response to policy shifts.
Question 5: A sunflower (spaghetti) chart displaying multiple GDP forecast paths from different models is most useful for:
- Selecting a single best-performing model
- Communicating forecast uncertainty and the range of plausible outcomes (Correct answer)
- Averaging forecasts into a consensus number
- Identifying seasonal adjustment errors
Correct answer: Communicating forecast uncertainty and the range of plausible outcomes
Fan or spaghetti charts show the distribution of forecast paths, making the range of uncertainty visible to policymakers and the public.
Question 6: In cost-benefit analysis, the social discount rate is used to:
- Adjust nominal costs for inflation to real terms
- Convert future costs and benefits to present value for comparison (Correct answer)
- Measure income inequality across beneficiaries
- Estimate administrative overhead costs
Correct answer: Convert future costs and benefits to present value for comparison
The social discount rate reflects society's time preference and is applied to future cash flows to make them comparable to present values.
Question 7: Which scenario is an example of 'regulatory capture' undermining policy evaluation?
- A regulator overfunds its own enforcement budget
- An industry-funded study that systematically understates a regulation's costs is used in the official RIA (Correct answer)
- Congress uses CBO scores to approve legislation
- An agency conducts a retrospective review of its rules
Correct answer: An industry-funded study that systematically understates a regulation's costs is used in the official RIA
Regulatory capture occurs when the regulated industry unduly influences the evaluative process, biasing analysis to favor industry interests over the public interest.
CEA Policy Evaluation & Economic Forecasting 4
When evaluating a minimum wage increase, a 'bunching estimator' identifies the effect by examining: