Chapter 12 - Instrumental Variables

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Lecture Slides:      Powerpoint     PDF

Learning Objectives

  • State the two necessary properties of a good instrumental variable
  • In real-world settings, articulate the two properties of a good instrument and critique the instruments used by researchers.
  • Apply the instrumental variables, or two-stage least squares, estimator to solve the endogeneity problem


  1. Consumption and Permanent Income
  2. Malaria, Institutions, and Economic Growth
  3. How Much Does Schooling Increase Wages?

Additional examples that we discuss in the textbook:

  1. The Supply and Demand of Food
  2. Do Migrant Remittances Increase Income Inequality?
  3. What’s a Year of College Worth?
  4. Economic Growth and Civil Wars
  5. Technology and Income Growth
  6. Class Size and Children’s Economic Performance

What We Learned

  • Good instruments must satisfy two conditions in order to convincingly solve the endogeneity problem.
    • IV1:  an instrument must be strongly correlated with the endogenous right-hand-side variable.
    • IV2:   an instrument must not be correlated with the error term in the main equation of interest.
  • Finding a good instrument is really hard