Pitfalls in counterfactual analyses of policy rules

This analysis examines the validity of utilizing a subset of reduced form equations, such as from a VAR model, for the construction of counterfactual policy analyses. It is shown that the omission of one of the estimated reduced form (VAR) equations and the substitution of a counterfactual policy rule to complete the model severely limits the admissible structure of the economic model that could have generated the historical data.