title: Essays in Macroeconomics
Creators: name: Kyriacou, Lucas Christopher Andreas
Publisher: name: Universität Bern
Year: 2023
Subjects: subject: 330 Economics

description: This dissertation consists of four separate essays on macroeconomics. The first three chapters present empirical contributions that focus on quantifying the impact of various shocks using time series models frequently used in modern macroeconomics. The last chapter has a different methodological scope. It develops a novel experimental format to simulate international climate change negotiations. In the first chapter, I quantify the role of autonomous fluctuations in consumer confidence in driving business-cycle fluctuations in the United States (US). This chapter concludes that confidence shocks play only a minor role in US business-cycle fluctuations. In the second chapter, I identify the main driver of business-cycle fluctuations in six advanced economies to establish a common international pattern. I find that business-cycles in advanced economies are all alike and driven by the same type of aggregate demand shock. In the third chapter, co-authored with Larissa Schwaller, we identify monetary policy shocks to investigate the cost central banks incur when attempting to lean against housing prices or credit aggregates using their interest rate instrument. We find that the effect of such policies is limited and associated with significant real economic costs. In the fourth chapter, co-authored with Klaus Schmidt and Elisa Hofmann, we develop a novel experimental format to simulate international climate change negotiations. We compare negotiations on individual commitments, as in the Paris agreement, with negotiations on a common commitment, such as a uniform global carbon price. We find that there is a significant and positive impact on long-term emissions when negotiations focus on a uniform global carbon price. 
Identifying and characterizing the causes and origins of business-cycle fluctuations is a long-standing quest of the macroeconomic profession. The existing literature has identified a plethora of shocks significant to business-cycle fluctuations. Prominent examples include technology shocks, such as neutral technology (N) shocks or investment-specific technology (IS) shocks, as well as monetary policy shocks, fiscal shocks, oil shocks, and uncertainty shocks. A comprehensive overview of commonly identified shocks is provided by Ramey (2016). In recent years, new literature has explored the idea that business-cycle fluctuations may originate predominantly from confidence shocks. Orthogonal to the fundamental state of the economy or news thereof, these shocks affect households’ and firms’ optimism or pessimism about the short-term economic outlook, causing shifts in aggregate demand. In my first dissertation chapter, I show that several existing approaches to the identification of such confidence shocks are unreliable, as they identify a role for confidence shocks even when applied to models that do not feature them by construction. The reason that these approaches are unreliable is that they impose weak and generic restrictions that are easily satisfied by random rotations of the model’s true structural disturbances. Working within a structural vector autoregression (SVAR) framework, I propose an alternative identification that imposes more stringent restrictions. The proposed scheme combines two parts. The first part identifies two permanent technology (N and IS) shocks with the ‘max-share identification’ approach pioneered by Uhlig (2003). In this approach, a shock is identified as the one that dominates the forecast error variance (FEV) of a particular variable at a specific horizon. Conditional on having identified permanent shocks, I use the approach of Arias et al. (2018) that imposes sign restrictions to identify several transitory shocks. I use the theoretical model of Angeletos et al. (2018), which includes confidence shocks in addition to traditional drivers of macroeconomic fluctuations, as a laboratory to test my identification scheme. The results indicate that the identification method always accurately recovers the permanent technology shocks. When applied to actual data for the US, the identification restrictions reveal that the two permanent technology shocks jointly explain a significant portion of all variables in the business-cycle band of 6-32 quarters. Based on the proposed identification scheme, the chapter concludes that confidence shocks only play a minor role in business-cycle fluctuations, while permanent technology shocks jointly explain a large portion of the observed variations. This conclusion is in line with Barsky and Sims (2012) and Fève and Guay (2019) who find a similarly minor role for autonomous fluctuations in confidence.
Angeletos et al. (2020) (ACD) recently introduced the concept of a ‘main business-cycle’ (MBC) shock to refer to the force that is responsible for the majority of business-cycle fluctuations in the key macroeconomic variables (output, investment, consumption, hours worked, and unemployment) in the US. Motivated by Lucas (1977), who famously observed that business-cycles are all alike, the objective of my second chapter is to investigate whether similar main drivers of business-cycles exist in the cross-section of advanced economies to assert that business-cycles are indeed all alike and driven by the same type of shock, the MBC shock. Estimating VARs and vector error correction models (VECMs), I identify the main drivers of business-cycle fluctuations in Australia, Canada, France, Italy, the United Kingdom, and the US to establish the existence of a common empirical template. Akin to the international business-cycle literature, I examine the comovement of the identified forces across countries and study the relationship between the main domestic business-cycle driver and variables related to international trade. To identify the main drivers of business-cycle fluctuations, I apply the identification strategy of ACD. Their approach also builds on the max-share approach of Uhlig (2003). Three crucial differences stand out relative to the approach taken in the previous chapter. First, instead of maximizing the FEV of a particular variable at a specific long-run horizon in the time domain, spectral decomposition is used to isolate the variance of a particular variable within a specific frequency band. The use of spectral decomposition allows to examine different frequency components of the data in isolation. I consider two frequency bands, one associated with the business-cycle (6-32 quarters) and one associated with the long-run (80-∞ quarters). Second, unlike the structural identification of transitory shocks via the sign restriction approach of Arias et al. (2018), ACD’s approach does not impose any restrictions motivated by economic theory nor does it identify a structural shock as in the first chapter. Instead, it identifies a particular shock as the one that contributes the most to the volatility of a particular variable over a specific frequency band. The recovered shock should therefore be seen as the dominant driver of a specific variable at a particular frequency. Third, ACD’s strategy consists of taking multiple cuts of the data by varying the targeted variable and frequency band. By targeting different variables, the same shock may be identified for multiple variables. Yet, these multidimensional cuts of the data help characterize the properties of the main business-cycle driver I aim to identify. Echoing Lucas (1977) in that business-cycles are all alike, I find support for the existence of an MBC shock, a single dominant force in each country that explains the bulk of macroeconomic fluctuations, triggers strong comovement in the main macroeconomic variables, and a countercyclical reaction of net exports as imports increase by more than exports. Moreover, each MBC shock is disconnected from inflation, the terms of trade, and the supply forces that drive economic activity in the long-run. In line with recent research in the international business-cycle literature (Levchenko and Pandalai-Nayar (2020) and Huo et al. (2020)) that propose demand-side shocks to be important drivers of international business-cycle comovement, I find that the identified MBCs play a significant role in explaining international output comovement.
Since the Great Financial Crisis (GFC), an intensive discussion around leaning against the wind (LAW) policies has emerged. LAW policies involve central banks pursuing a tighter monetary policy than what is consistent with inflation targeting, without taking financial stability effects into account. On the one hand, LAW policies can potentially reduce the probability and magnitude of crises. On the other hand, they can lead to a weaker economy, lower GDP, higher unemployment, and lower inflation rates. The dominant view among economists is that the costs of LAW policies outweigh the benefits by a significant amount (see Svensson (2017), Schularick et al. (2021), Benati (2021), and Benati (2022)). However, there is also a minority position that central banks should pursue financial stability-oriented monetary policy, which involves deviating temporarily from traditional objectives to avert a financial crisis when signs of imbalances emerge (see BIS (2014) and BIS (2016)). In my third chapter, we measure the costs central banks face when implementing LAW policies using their interest rate instrument. We focus on leaning against housing prices and credit aggregates and evaluate the costs in terms of relative real GDP losses. We estimate VARs and use an external instrument identification strategy to identify monetary policy (MP) shocks. This approach has been developed by Stock and Watson (2012) and Mertens and Ravn (2013) and is commonly referred to as Proxy-SVAR. The advantage of using this framework is that it does not impose a particular theory on how a MP shock should affect any variables as done by using e.g., zero and sign restrictions. We use data for the US and consider the frequentist Proxy-SVAR approach by Gertler and Karadi (2015) and the Bayesian approach by Arias et al. (2021). As an external instrument, we use the orthogonalized monetary policy surprises (MPS) of Bauer and Swanson (2022). MPS are high-frequency changes in interest rates around Federal Open Market Committee (FOMC) announcements. Recently, some studies raised concern about the exogeneity of MPS because they found that they are systematically correlated with economic and financial data that is available prior to FOMC announcements. Bauer and Swanson (2022) correct for this issue by orthogonalizing their MPS with respect to economic and financial data that predate FOMC announcements. This treatment ensures the exogeneity of MPS and their validity as an instrument for identifying MP shocks. Based on our combination of state-of-the-art identification methods and the improved measures of MPS, we find that the impact of an unexpected 25 basis point interest rate hike on real housing prices or real credit is not significantly larger than the impact on real GDP. In line with the literature that advocates against LAW policies, we find that the ability of the Federal Reserve to correct disequilibria in asset price markets or credit markets appears limited and is associated with significant real economic costs.
Climate change can only be mitigated if sovereign countries negotiate effective international cooperation. The success of these negotiations depends on how they are structured. In the Paris agreement negotiations, countries negotiated a common, non-binding goal of how much to limit global warming. This goal is to be implemented by ‘nationally determined contributions’, i.e., individual commitments by the participating countries of how much to contribute to the common good. Weitzman (2014), Weitzman (2017), Nordhaus (2015), Nordhaus (2019), MacKay et al. (2015), and others propose to focus climate negotiations on a uniform minimum price for carbon emissions instead. This negotiation design strives for a common commitment that builds on reciprocity. While there are several theoretical arguments for focusing climate change negotiations on a carbon price, almost no empirical or experimental evidence exists to test which negotiation protocol is more successful in achieving ambitious climate action. In my fourth chapter, we investigate whether negotiating a uniform commitment (such as a carbon price) achieves more ambitious CO2 reductions than individual commitments (such as the negotiations that led to the Paris Agreement). We provide a novel field experiment that allows us to simulate climate change negotiations by the Conference of the Parties (COP), the main body of the United Nations Framework Convention on Climate Change (UNFCCC). We collaborated with Model United Nations (MUN) associations at Universities in Germany and Switzerland. MUN is a formally structured framework to simulate complex negotiations. Participants take on the role of diplomats and represent various countries to simulate actual committees of the UN at international conferences around the world. Delegates conduct research, adhere to formal rules of debate, negotiate in plenary and informal discussions, and vote on resolutions. We simulate two committees, each with the same ten countries, including major CO2 emitters, major producers of fossil fuels, and developing countries. The two committees are experimental treatments that differ in only one respect. In one committee, individual commitments are negotiated, similar to the Paris Agreement. In the second committee, negotiations aim at a common uniform commitment with a uniform global carbon price. Our experiment is designed to simulate realistic, dynamic negotiations in a formally structured setting to create replicable conditions that enable the demonstration of statistically valid results. We find that focusing climate change negotiations on a single carbon price has a significant and positive impact on long-term emissions reductions, higher participation in the resolution, and more equal contributions than negotiating individual commitments as in the Paris agreement. Taken together, our results suggest that the international community should give the approach of negotiating a uniform global carbon price serious consideration.