The Impact Of Economic Policy Uncertainty On The Business Cycle

This thesis based on a factor model analysis of the impact of economic policy uncertainty(EPU)on the macroeconomic cycle in China.Firstly,the thesis uses an economic policy uncertainty index to comprehensively measure economic policy uncertainty in China;It analyzes the principle of factor models to measure economic cycles,and under the theoretical premise of Bai & Ng(2002)consistent estimation of the number of factors,it conducts Monte Carlo simulations.The study shows that the testing method in the article can accurately predict the number of factors even under different information criteria,in a limited sample size.Secondly,using a high-dimensional time series of China’s macroeconomic data from January2000 to December 2022,three common factors are extracted.The analysis shows that Factor1 mainly represents the series of output and income,Factor 2 can be used as a factor reflecting the labor market and interest rate market,and Factor 3 focuses on the price index series.These factors are used to identify the underlying economic factors driving the economic cycle and quantify the impact of policy uncertainty on these factors.This article constructs a VAR model to explore the impact of economic policy uncertainty on the economic cycle.The Granger causality test shows that EPU can affect the economic cycle through fixed asset investment.There may be a potential causal relationship between economic policy uncertainty and the economic cycle,which leads to endogeneity and estimation bias.Therefore,the thesis further divides economic policy uncertainty into three parts:(1)independent decisions made by policy-makers based on political stance or personal views;(2)uncertainty factors caused by unforeseeable events or uncontrollable forces;(3)policy adjustments based on economic cycles.The first category can be seen as an exogenous variable,while the second category is extreme events or disasters,such as the global COVID-19;the third category can be regarded as an endogenous variable.This thesis uses lagged common factors and the pandemic to control for the endogeneity of the impact of the economic cycle on economic policy uncertainty.Based on the fact that the pandemic has a one-way causal relationship with both the economic cycle and economic policy uncertainty,by two-stage least squares method the thesis finds that economic policy uncertainty will affect Factor 2,namely the role of interest rates and labor market,through investment.