Essays in applied macroeconomics: dynamic effects of monetary and financial shocks
Keywords: applied macroeconomics
monetary economics

In Chapter 1, I analyse how the response of the United Kingdom (UK) economy to monetary policy shocks depends on the state of the economy, or the sign or size of the shock. Monetary policy shocks are identified by extending the Cloyne and Hurtgen (2016) approach to allow for time-variation in the central bank reaction function. Crucially, this extension results in a shock series that distinguishes between variations in the reaction function (for example, as a result of evolving monetary policy regimes) and innovations to the reaction function. The new shock series is used to estimate impulse responses by nonlinear local projections following Tenreyro and Thwaites (2016) to provide novel empirical evidence of the asymmetric effects of monetary policy in the UK. The main result is that shocks that occur during economic expansions have significantly larger effects than those that occur during recessions. This is consistent with evidence for the United States (US) in Tenreyro and Thwaites (2016) and the cross-country study by Jorda et al. (2018). In addition, I find that expansionary shocks are more powerful than contractionary shocks, and that large shocks have a proportionally weaker effect on output than small shocks. The results are robust to alternative monetary policy shock identification methods and variations in the empirical specification.
In Chapter 2, I investigate if the effects of financial and monetary policy shocks differ between high and low credit regimes in Australia. I estimate a factor-augmented smooth-transition vector autoregression model to estimate the state-dependent effects of financial and monetary shocks. The factor is a broad indicator of aggregate financial conditions extracted from a large set of financial variables, while the transition between credit regimes is determined by the deviation of household credit-to-GDP from its long-run equilibrium. The main result is that the adverse effects of an unanticipated tightening in financial conditions on output are far more pronounced when the shock occurs in a high credit regime than in a low credit regime. Sectoral models indicate that the asymmetric output response is largely driven by the state-dependent responses in the construction and manufacturing industries. In addition, financial shocks are found to be a significant source of business cycle fluctuations, especially in a high credit regime. The results are consistent with high credit regimes coinciding with periods of increased macroeconomic vulnerability where the economy is more prone to adverse financial shocks. I also find that monetary policy shocks lead to significantly larger and more persistent output and inflation responses in a low credit regime, consistent with the idea that monetary policy is most potent when households are credit constrained. The results are robust to alternative recursive identification orderings, controlling for foreign financial shocks and a range of alternative empirical specifications.
In Chapter 3, I analyse the determinants of the decline in the natural rate of interest (NRI) - the short-term real interest rate consistent with a zero output gap and stable inflation - over 1984 to 2016. To empirically analyse the determinants, I estimate the NRI for the US and the UK using three different approaches: a semi-structural model, a time-varying parameter vector autoregression, and a novel financial market-based approach. These estimates are used to analyse long-run equilibrium determinants of the NRI by estimating country-level dynamic regressions using a general-to-specific model selection algorithm. In comparison to the existing empirical literature, the model includes a larger set of NRI determinants than many studies and incorporates economic uncertainty and the demand for safe assets which have typically been overlooked in previous empirical studies. Most notably, I find evidence of a negative relationship between the NRI and economic uncertainty in both the US and the UK, while both productivity growth and the relative price of capital are positively related to the NRI. The decline in the NRI over 1984 to 2016 has predominantly been associated with a persistent decline in the relative price of capital in the US and an increase in population growth in the UK. Since the 2007--2008 financial crisis, the 1.5-2 percentage point fall in the NRI in both economies was largely associated with a decline in productivity growth and heightened economic uncertainty.