| Summary: | What drives business cycles? Traditional explanations, based on policy
interventions and supply side changes, have been found empirically incomplete.
This thesis examines the relative contribution of changes in beliefs to business
cycles from theoretical and empirical perspectives.
The first essay evaluates quantitatively the U.S. investment boom and bust of
the late 1990s and early 2000s. Revisions of optimistic beliefs are commonly
viewed as the key determinant of investment during this period. Yet, can this view
explain consistently the joint behaviour of consumption, investment and
employment? A standard real business cycle model with technology shocks
performs relatively well in capturing the boom, but very poorly in explaining the
bust. Beliefs about future technology are introduced into this model by enriching
the economy information set and identified from a discrepancy between the model
and the data. The augmented model can only account for the joint behaviour of
aggregate variables when expectations about the future are more pessimistic during
the boom and more optimistic during the recession.
The second essay derives and tests a necessary condition for beliefs about
future technology to be an independent source of business cycles. The essay's
premise is that expectations are rational, but current and past realizations of
technology do not fully summarize information relevant for forecasting future
technology. This premise necessarily implies long-run predictability of technology
shocks. Measures of total factor productivity, orthogonal to monetary and fiscal
policy shocks, provide empirical support for this premise in the U.S. post World
War II period. Macroeconomic variables help to forecast future realizations of TFP
growth up to two years.
The third essay asks whether changes in beliefs due to extra information about
the future (news shocks) are different from changes in beliefs due to extrinsic
uncertainty (sunspot shocks). The essay incorporates news into linear rational
expectations models with unique and multiple equilibria. Based on general forms
of solutions and numerical simulations of a New Keynesian model, the essay
demonstrates that news and sunspots have distinct predictions for dynamic
properties of equilibria. Since the differences can be quantitatively significant,
these predictions can be used to separate news and sunspots empirically. === Arts, Faculty of === Vancouver School of Economics === Graduate
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