Essays on Uncertainty and Business Cycle Fluctuations

Abstract

This thesis is a collection of three self-contained chapters that explore external vulnerability of different economies in terms of exposure to global uncertainty shocks and business cycle synchronisations. The first chapter acts as background to Chapters 2 and 3, and provides a literature review of the main themes explored in this thesis. It explores the different types of uncertainty shocks, the different ways of measuring uncertainty and analyses the effects of uncertainty shocks, including their effects on trade flows. I further outline the business cycle synchronisation literature, highlighting the heterogeneity in different economies’ exposure to global business cycle shocks, and exploring whether business cycles may be connected at a regional level or across economies sharing similar income levels. Chapter 3 investigates how global economic, financial and trade policy uncertainty affect the trade flows of the seven largest emerging economies (EM-7) using a panel structural vector autoregressive model. Emerging economies are particularly exposed to uncertainty shocks, having mostly adopted export-led growth strategies and tending to specialise in a small subset of goods. Furthermore, they are relatively less financially integrated. We find that global economic uncertainty and trade policy uncertainty act as barriers to trade, leading to a protracted decline in EM-7’s degree of openness and deteriorating their trade balance to GDP ratio. Global economic uncertainty shocks induce a 3–4% decline in imports and exports, and trade policy uncertainty shocks cause trade flows to contract by 4-5%. In contrast, financial uncertainty only has a short-lived impact on emerging economies’ trade flows, triggering a 2% contemporaneous decline in imports and exports, with the impulse responses turning statistically insignificant shortly after. Trade policy uncertainty is the most important type of uncertainty affecting trade flows, explaining 11% of the variation in trade flows. 7-8% of the movement in imports and exports is explained by global economic uncertainty shocks, and less than 2% is explained by global financial uncertainty shocks. Chapter 4 explores business cycle interdependence across economies. Using a Factor Augmented Vector Auto Regressive model, I estimate the impact of becoming more integrated with a global business cycle, a regional business cycle, as well as a business cycle common to economies having similar income levels on domestic business cycles. I find that business cycle fluctuations are driven primarily by external shocks rather than domestic shocks. The 2007/8 Global Financial Crisis stands out as the most synchronised recession over the 1995-2019 sample. Nonetheless, global shocks have waned over the latter part of the sample, and regional shocks have become more important. Emerging economies’ business cycles are more volatile than advanced economies’, and they are also more synchronised with each other. By estimating a group-specific factor that accounts for both income levels and region, I find that emerging economies are more vulnerable to regional shocks than advanced economies.