Here is an excerpt from a December 5th blog post Evidence in Macroeconomics by Paul Krugman. It’s a nice summary of our readings on how to test the size of the multiplier, the challenge posed by endogeneity, and hence the value of “natural experiments.”
Anyway, where Noah [Smith, link] goes too far is in asserting that this kind of thing means that we basically know nothing [in critiquing David Beckworth here]. Um, no — good economists have been aware of this problem [endogeneity] for a long time, and serious work on both monetary and fiscal policy takes it into account. How? By looking for natural experiments – cases of large changes in policy (so that policy is the dominant factor in what happens) that are clearly not a response to the state of the business cycle.
That’s why Milton Friedman and Anna Schwartz’s monetary history wasn’t just about correlations; it relied on a narrative method to attempt to show that the monetary movements it stressed were more or less exogenous.