An Empirical evaluation of the responsiveness of the Australian economy to economic shocks

This thesis explores three distinct topics regarding the responsiveness of the Australian economy to economic shocks. Specifically, this thesis investigates the responsiveness of the Australian economy to global GDP shocks and global policy interest rate shocks, Australian monetary policy shocks, and to increases in Australian government expenditure. Understanding how the Australian economy responds to economic shocks is important as Australian policymakers are concerned with macroeconomic stability. 

The first paper in this thesis uses a block recursive structural VAR model to estimate the responsiveness of the Australian economy and relevant commodity prices to GDP shocks and policy interest rate shocks from the U.S. and from China. The estimates indicate that the Australian economy and commodity prices are more responsive to a GDP shock from the U.S. compared to a GDP shock from China. However, the responsiveness of the Australian economy to Chinese GDP shocks has increased substantially over time. The Australian economy is found to be more responsive to a Chinese policy interest rate shock compared to a U.S. policy interest rate shock although, unlike the U.S. policy interest rate shock, the Chinese policy interest rate shock is not consistent with a contractionary monetary policy shock. This is because the response of the Chinese price level to the Chinese policy interest rate shock is to increase (rather than decrease) which is evidence of a price puzzle. The U.S. policy interest rate shock leads to a decrease in commodity prices whilst the Chinese policy interest rate shock leads to an increase in commodity prices. 

The second paper in this thesis explores monetary policy shock identification for the Australian economy by using three distinct SVAR models. The first structural model is identified recursively. The second structural model is identified non-recursively by allowing for the contemporaneous interdependence between the cash rate and the real exchange rate but imposes zero restrictions on the contemporaneous responses of the cash rate to movements in the GDP level and the inflation rate. The third structural model allows for the contemporaneous interdependence between the cash rate and the real exchange rate but imposes a zero long-run restriction on the impact of the cash rate on the real exchange rate (a monetary neutrality restriction). The results in this paper indicate that, out of the three considered models, a contractionary monetary policy shock identified using the non-recursive model does not result in correctly specified contemporaneous coefficients in the structural equation for the cash rate even though there are no puzzles in the response to the cash rate shock. This is not the case for the model with the long-run restriction. In the model with the long-run restriction, while the contemporaneous coefficients in the structural equation for the cash rate have the correct sign, there are puzzles in the response to the cash rate shock. 

The third paper in this thesis provides insights into the effectiveness of government expenditure as a form of fiscal stimulus by estimating state-dependent government consumption and government investment multipliers. The sets of states that are considered are states of tight and loose monetary policy and states with and without economic slack. The results indicate that government consumption multipliers are largely invariant to the prevailing state of monetary policy but are different across states with and without economic slack. In contrast, the sizes of the government investment multipliers are found to be largely invariant across both sets of states (monetary policy states and states with and without economic slack). The results in this paper imply that the Australian government should utilise government consumption expenditure rather than government investment expenditure to stimulate GDP.