Uncertainty, expectations, and the business cycle
Title: Uncertainty, expectations, and the business cycle
Author: LANG, Jan Hannes
Citation: Florence : European University Institute, 2012
Series/Report no.: EUI PhD theses; Department of Economics
This thesis adds to the recent quantitative literature that considers variations in uncertainty as impulses driving the business cycle. In chapter one a flexible partial equilibrium model that features heterogeneous firms, uncertainty shocks and various forms of capital adjustment costs is built in order to reassess whether temporarily higher uncertainty can cause recessions. It is then shown that while uncertainty shocks to demand can cause the bust, rebound and overshoot dynamics reminiscent of recessions, uncertainty shocks to total factor productivity are likely to lead to considerable and prolonged booms in economic activity. The reason for this result is that while the expectational effect of uncertainty shocks is negative and similar in magnitude for both types of uncertainty shocks, the positive distributional effect is an order of magnitude larger for total factor productivity than for demand. Chapter two then derives and implements an identification strategy for uncertainty shocks within a Structural Vector Autoregression framework that is consistent with the way these shocks are commonly modeled in the literature. For the US it is shown that such model consistent uncertainty shocks lead to considerable booms in investment and employment and only explain a small fraction of the variation in the cross-sectional sales variance. Once uncertainty shocks are identified as the shocks that only affect dispersion upon impact, they cause a moderate drop, rebound and overshoot of investment and a large increase in the cross-sectional dispersion of revenues. The results suggest that the standard timing assumption that the expectational effect of uncertainty shocks leads the distributional effect seems questionable. Finally, chapter three analyses endogenous variations in uncertainty and their effect on aggregate dynamics that result from imperfect information in the presence of occasional regime shifts. In a tentative model parameterization to the German manufacturing industry during the Financial Crisis it is shown that after a temporary regime shift imperfect information leads endogenously to higher forecast standard errors compared to full information, as well as higher cross-sectional dispersion of mean forecasts and forecast standard errors. It is then shown that these endogenous variations in uncertainty can lead to considerable downward amplification and some propagation of aggregate investment and revenues during a temporary downward regime shift.
Defence date: 15 November 2012; Examining Board: Professor Russell Cooper, Penn State University (External Supervisor); Professor Árpád Ábrahám, European University Institute; Professor Cristina Arellano, Federal reserve Bank of Minneapolis; Professor Steve Bond, University of Oxford.
Type of Access: openAccess