Time Fixed Effects

Time fixed effects $\lambda_t$ are dummy variables — one per time period — that absorb whatever happens uniformly across all units in that period. National recessions, federal policy shocks, technology rollouts, fuel-price spikes — anything that hits all units in year $t$ equally is captured by $\lambda_t$ and removed from the residual. They are the flexible, no-functional-form alternative to a linear time trend.

When to use

Add time FE whenever common-shock confounders are plausible. PS_4's FE2 specification uses year dummies to absorb every nationwide shock — the 1995 repeal of the 55 mph limit, federal airbag mandates, recessions — without imposing that they happen on a smooth time path. The cost is a handful of degrees of freedom (one dummy per time period). When combined with individual FE → Two-Way Fixed Effects → the canonical Difference-in-Differences design.