Your textbook presents as an example of a distributed lag regression the effect of the weather on the price of orange juice

Question

The authors mention U.S. income and Australian exports, oil prices and inflation, monetary policy and inflation, and the Phillips curve as other potential candidates for distributed lag regression. You are considering estimating the effect of minimum wages on teenage employment (employment population ratio) using a time series of U.S. data. Write a short essay on whether a distributed lag model would be a suitable tool to figure out dynamic causal effects in this case.
What will be an ideal response?

Answer 1

Answer: One of the first questions student must address is whether or not the X variable here is exogenous. In studies of the labor market, e.g. microeconomics, students learned that it is real wages that determine employment, not nominal wages. Some authors have used relative wages as an explanatory variable, where the denominator is average hourly earnings. Setting aside whether or not minimum wages are exogenous, the students should then focus on whether the price index used to adjust nominal minimum wages or average hourly earnings are exogenous. However, most students will focus only on the numerator (nominal minimum wages) and will argue that minimum wages are typically set by the legislature following some political process and may therefore be considered exogenous. Some will go further and argue that the process of setting minimum wages will depend on the state of the business cycle. For example, recent increases in minimum wages (2007, 2008, 2009) would most likely not have occurred if legislators would have anticipated teenage unemployment rates of over 25% for teenagers. If that is the case, then minimum wage legislation depends on the state of the business cycle and hence teenage employment. As a result, minimum wages should not be considered exogenous.