Pooling Cross

Sections across
Chapter 13
Time: Simple Panel
Data Methods

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 Pooling Cross Sections across Time:
Simple Panel Data Methods

● Policy analysis with pooled cross sections

• Two or more independently sampled cross sections can be used to
evaluate the impact of a certain event or policy change

● Example: Effect of new garbage incinerator’s location on

housing prices
• Examine the effect of the location of a house on its price before and
after the garbage incinerator was built: After incinerator
was built

Before incinerator
was built

© 2016 Cengage Learning ®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Pooling Cross Sections across Time:
Simple Panel Data Methods

● Example: Garbage incinerator and housing prices (cont.)

• It would be wrong to conclude from the regression after the
incinerator is there that being near the incinerator depresses prices
so strongly
• One has to compare with the situation before the incinerator was
built:

Incinerator depresses prices but location

was one with lower prices anyway
• In the given case, this is equivalent to

● This is the so called difference-in-differences estimator (DiD)

© 2016 Cengage Learning ®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Pooling Cross Sections across Time:
Simple Panel Data Methods

● Difference-in-differences in a regression framework

Differential effect of being in the location and after the incinerator was built

• In this way standard errors for the DiD-effect can be obtained

• If houses sold before and after the incinerator was built were sys-
tematically different, further explanatory variables should be
included
• This will also reduce the error variance and thus standard errors

● Before/After comparisons in “natural experiments”

• DiD can be used to evaluate policy changes or other exogenous
events
© 2016 Cengage Learning ®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Pooling Cross Sections across Time:
Simple Panel Data Methods

● Policy evaluation using difference-in-differences

Compare outcomes of the two groups

before and after the policy change

Compare the difference in outcomes of the units that are affected by the policy change (= treatment
group) and those who are not affected (= control group) before and after the policy was enacted.

For example, the level of unemployment benefits is cut but only for group A (= treatment group).
Group A normally has longer unemployment durations than group B (= control group). If the diffe-
rence in unemployment durations between group A and group B becomes smaller after the reform,
reducing unemployment benefits reduces unemployment duration for those affected.

Caution: Difference-in-differences only works if the difference in outcomes between the two groups
is not changed by other factors than the policy change (e.g. there must be no differential trends).

© 2016 Cengage Learning ®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Pooling Cross Sections across Time:
Simple Panel Data Methods

● Two-period panel data analysis

● Example: Effect of unemployment on city crime rate

• Assume that no other explanatory variables are available. Will it be
possible to estimate the causal effect of unemployment on crime?
• Yes, if cities are observed for at least two periods and other factors
affecting crime stay approximately constant over those periods:

Time dummy for Unobserved time-constant Other unobserved factors

the second period factors (= fixed effect) (= idiosyncratic error)

© 2016 Cengage Learning ®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Pooling Cross Sections across Time:
Simple Panel Data Methods

● Example: Effect of unemployment on city crime rate (cont.)

Subtract:

Fixed effect drops out

● Estimate differenced equation by OLS:

+ 1 percentage point unemploy-

ment rate leads to 2.22 more
crimes per 1,000 people

Secular increase in crime

© 2016 Cengage Learning ®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.
 Pooling Cross Sections across Time:
Simple Panel Data Methods

● Discussion of first-differenced panel estimator

• Further explanatory variables may be included in original equation
• Note that there may be arbitrary correlation between the unobserved
time-invariant characteristics and the included explanatory variables
• OLS in the original equation would therefore be inconsistent
• The first-differenced panel estimator is thus a way to consistently
estimate causal effects in the presence of time-invariant endogeneity
• For consistency, strict exogeneity has to hold in the original equation
• First-differenced estimates will be imprecise if explanatory variables
vary only little over time (no estimate possible if time-invariant)

© 2016 Cengage Learning ®. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part, except for use as permitted in a license distributed with a
certain product or service or otherwise on a password-protected website or school-approved learning management system for classroom use.