City skyline merging into an economic growth graph.

Are We Misreading the Economy? The Truth About Local Projections

Lena Kashyap in Business & Economy December 2025 • 4 min read.

"Dive into the world of economic analysis with local projections, a powerful tool that's reshaping how we understand economic trends and predict future impacts."

In today's rapidly evolving economic landscape, understanding the potential impacts of various events and policy changes is more critical than ever. Traditional methods often fall short in providing a clear picture, leading economists to seek more agile and insightful tools. Enter local projections, a technique gaining traction for its ability to estimate impulse responses—how the economy reacts to specific shocks or interventions.

Local projections offer a way to assess these dynamic evolutions, helping analysts determine if an impulse generates a response that significantly deviates from a null effect. Unlike traditional models that can be restrictive, local projections allow for a more agnostic approach, letting the data speak for itself without imposing strong assumptions about the underlying economic structure. This makes them particularly valuable in complex scenarios where the data generating process is uncertain.

This article provides an overview of local projections, exploring their strengths, limitations, and how they compare to other methods like vector autoregressions (VARs). We'll delve into the different types of inference used with local projections, including point-wise, simultaneous, and significance-based approaches. Whether you're an economist, a policymaker, or simply someone keen to understand the forces shaping our economy, this guide will equip you with valuable insights into this cutting-edge technique.

What are Local Projections and Why are They Gaining Popularity?

City skyline merging into an economic growth graph.

Local projections, introduced by Jordà in 2005, represent a departure from traditional methods by directly estimating impulse responses without relying on a fully specified structural model. This is achieved by projecting future outcome variables on current and past information related to the intervention or impulse. In simpler terms, local projections involve running a series of regressions, each focused on a different future time horizon, to trace out the dynamic effects of a given shock.

This approach offers several advantages. First, it's more flexible than VARs, as it doesn't require specifying the entire system of equations. Second, local projections are less prone to bias, especially when dealing with non-linearities or structural breaks in the data. Third, they provide a more direct way to estimate impulse responses, as each projection focuses on a specific horizon, avoiding the accumulation of errors that can occur in iterative methods.

Flexibility: Local projections do not require a fully specified structural model, making them adaptable to various economic settings.
Reduced Bias: They are less prone to bias, especially when dealing with non-linearities or structural breaks in the data.
Direct Estimation: Each projection focuses on a specific horizon, avoiding error accumulation common in iterative methods.

While local projections offer numerous benefits, they also come with their own set of challenges. One key issue is inference, as assessing the precision and significance of the estimated impulse responses requires careful consideration. This involves choosing appropriate methods for constructing confidence intervals and conducting hypothesis tests, taking into account the potential for heteroscedasticity and autocorrelation in the data. Recent research has focused on developing more robust and efficient inference procedures for local projections, enhancing their reliability and applicability.

Navigating the Future with Local Projections

As the field of economics continues to evolve, methods like local projections offer a flexible and robust approach to understanding the complex relationships that drive our economies. By embracing these innovative techniques, analysts and policymakers can gain deeper insights and make more informed decisions, ultimately leading to a more stable and prosperous future. Whether dissecting the nuances of monetary policy or evaluating the broad impacts of global events, local projections are proving to be an invaluable tool for those seeking to understand the economic forces shaping our world.

About this Article -

This article was crafted using a human-AI hybrid and collaborative approach. AI assisted our team with initial drafting, research insights, identifying key questions, and image generation. Our human editors guided topic selection, defined the angle, structured the content, ensured factual accuracy and relevance, refined the tone, and conducted thorough editing to deliver helpful, high-quality information.See our About page for more information.

This article is based on research published under:

DOI-LINK: https://doi.org/10.48550/arXiv.2306.03073,

Title: Inference For Local Projections

Subject: econ.em stat.ap

Authors: Atsushi Inoue, Òscar Jordà, Guido M. Kuersteiner

Published: 05-06-2023

Everything You Need To Know

What are local projections in economics, and how do they work?

Local projections are a method for economic forecasting introduced by Jordà in 2005. They estimate impulse responses by projecting future outcome variables on current and past information related to an intervention or impulse. This involves running a series of regressions, each focused on a different future time horizon, to trace the dynamic effects of a given shock. Unlike traditional models, local projections do not require a fully specified structural model, offering a flexible and data-driven approach.

How do local projections differ from traditional economic models like VARs?

Local projections differ significantly from traditional methods such as Vector Autoregressions (VARs). VARs require specifying a complete system of equations, which can be restrictive. Local projections, on the other hand, are more agnostic, allowing the data to inform the analysis without strong assumptions about the underlying economic structure. This flexibility makes local projections less prone to bias, especially when dealing with non-linearities or structural breaks, providing a more direct way to estimate impulse responses.

What are the key advantages of using local projections in economic analysis?

Local projections offer several key advantages. They are more flexible than VARs because they do not need a fully specified structural model, adapting to various economic settings. They are also less prone to bias, particularly when dealing with non-linearities or structural breaks in the data. Furthermore, local projections provide a more direct way to estimate impulse responses, focusing on specific horizons and avoiding the accumulation of errors common in iterative methods. This makes them valuable for understanding the impacts of economic shocks and policy changes.

What challenges are associated with using local projections, and how are researchers addressing them?

One key challenge with local projections is inference, which involves assessing the precision and significance of the estimated impulse responses. This requires careful consideration of methods for constructing confidence intervals and conducting hypothesis tests, accounting for heteroscedasticity and autocorrelation in the data. Researchers are actively developing more robust and efficient inference procedures to enhance the reliability and applicability of local projections.

How can understanding local projections help policymakers and economists make better decisions?

By utilizing methods like local projections, policymakers and economists can gain deeper insights into the complex relationships driving economies. Local projections offer a flexible and robust approach to understanding economic trends and predicting future impacts. This allows for more informed decisions regarding monetary policy and broader economic strategies. This ultimately contributes to a more stable and prosperous economic future by providing valuable tools for analyzing the effects of various events and policy changes.