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http://hdl.handle.net/11375/22848
Title: | An Investigation into News Driven Business Cycles of Small Open Economies |
Authors: | Obaid, Sabreena |
Advisor: | Letendre, Marc-Andre |
Department: | Economics |
Publication Date: | 2017 |
Abstract: | In this thesis we examine the news driven business cycle hypothesis which posits that business cycles might arise purely on the basis of expectations of future changes. Although the news shocks literature often concentrates on news about future technological changes, we on the other hand, study news about a country interest rate and a monetary policy interest rate in the context of small open economies (SOEs). Country interest rate news shocks refer to the anticipated changes in the rate at which the SOE borrows/lends in the international financial markets. Monetary policy news on the other hand refers to the anticipated changes of the policy rate usually transmitted to the public through `forward guidance'. We argue that such pieces of news about interest rates change the expectations of economic agents and influence current economic activity without any actual change ever occurring. Further, we extend our SOE framework to study an optimal monetary policy rule for Canada. In Chapter 2, we examine how anticipated changes in future country interest rates influence the business cycles of emerging SOEs like Argentina and Mexico. To this end, we introduce country interest rate news shocks in a SOE model. We use annual Argentine data from 1900-2005 to estimate our model using Bayesian methods. We find that anticipated shocks to country interest rates explain a good deal of variations in the growth rate of investment and trade balance-output ratio of Argentina. The model also generates business cycles statistics that are consistent with those of Argentina. We find similar results for Mexico as well. In Chapter 3, we extend our SOE framework of Chapter 2 to a New Keynesian SOE model in order to explore the role of monetary policy news shocks in Canadian business cycles. Once again, we perform a Bayesian estimation of the model with Canadian and US data from 1981Q3-2012Q4. The novel feature of the monetary policy rule employed in this study is the inclusion of US interest rate deviations in the Canadian monetary policy rule motivated by the highly correlated US and Canadian short term nominal interest rates over the above mentioned time period. Our estimation results show that the response coefficient of Canadian monetary policy to US interest rate deviations is indeed positive. Moreover, both the unconditional and conditional variance decomposition of variables in the model reveal that although monetary policy news shocks explain some of the variation in the growth rate of output and consumption, overall they are not a major source of Canadian business cycles. However, they explain a good portion of the variation in money supply growth and inflation in Canada. Chapter 4 builds on the New Keynesian Dynamic Stochastic General Equilibrium (DSGE) framework developed in Chapter 3. In this chapter, we ask the following question: does reacting to US interest rate changes help the central bank achieve its mandate? To this end, we represent the mandate of the central bank by a loss function which is a linear combination of the variances of inflation, output gap and nominal interest rate changes which the central bank seeks to minimize. The weights attached to each of the three terms of the loss function represent different policy regimes. We assess the performance of the estimated interest rate rule of Chapter 3 with and without reaction to US interest rate deviations in achieving the central bank's mandate under different policy regimes. We find that under the estimated rule, reacting to US interest rate deviations neither helps nor hurts the central bank to achieve its mandate. Next, we ask the following questions: what values of the policy coefficients would minimize the loss function and would the optimal simple rule include US interest rate deviations in it? We find that the optimal rule has a positive coefficient on US interest rate deviations (larger than its Bayesian estimate) for all the policy regimes. It also has a large coefficient on inflation. Therefore, our analysis suggests that the central bank should include US interest rate deviations in its reaction function and should react even more aggressively to US interest rate changes and inflation than it did based on our Bayesian estimates. |
URI: | http://hdl.handle.net/11375/22848 |
Appears in Collections: | Open Access Dissertations and Theses |
Files in This Item:
File | Description | Size | Format | |
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obaid_sabreena_so_201712_PhD.pdf | 2.81 MB | Adobe PDF | View/Open |
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