As the Federal Reserve continues to normalize its monetary policy, this paper studies the impact of U.S. interest rates on rates in other countries. We find a modest but nontrivial pass-through from U.S. to domestic short-term interest rates on average. We show that, to a large extent, this comovement reflects synchronized business cycles. However, there is important heterogeneity across countries, and we find evidence of limited monetary autonomy in some cases. The co-movement of longer term interest rates is larger and more pervasive. We distinguish between U.S. interest rate movements that surprise markets versus those that are anticipated, and find that most countries receive greater spillovers from the former. We also distinguish between movements in the U.S. term premium and the expected path of risk-free rates, concluding that countries respond differently to these shocks. Finally, we explore the determinants of monetary autonomy and find strong evidence for the role of exchange rate flexibility, capital account openness, but also for other factors, such as dollarization of financial system liabilities, and the credibility of fiscal and monetary policy. JEL Classification Numbers: C13, C15, E32, E43, E47, E52, E58, F44.
a b s t r a c t a r t i c l e i n f oThe exchange rate is an important part of the transmission mechanism in the determination of monetary policy because movements in the exchange rate have significant effect on the macroeconomy. It can be difficult to measure the reaction of monetary policy to the movements of the exchange rate, due to the simultaneous response of monetary policy to the exchange rate and the possibility that both variables respond to several other variables. This study addresses these problems by using an identification method based on the heteroscedasticity in the high-frequency data. The results in this paper suggest that the ECB systematically responds to exchange rate movements but that quantitative effects are small. Such a significant but small reaction coefficient seems consistent with the hypothesis that the central banks do not target the fluctuations in the exchange rate but consider them only to the extent they impact on the expected inflation and output path.
This paper investigates the implicit inflation targets of inflation targeting (IT) central banks (CBs). The implicit (perceived) inflation targets of IT CBs derived from their actions (policy interest rates) are calculated before and after IT adoption. We conclude that after adoption of IT implicit targets become significantly lower. Other factors that cause CBs to change their implicit targets are inflation, exchange rate and trade balance. Finally, we find that CBs that do not follow their announced targets miss their inflation targets. The results indicate that IT CBs should follow their announced targets when setting policy interest rates.
This paper investigates the impact of European Central Bank's unconventional monetary policies between 2008-2016 on the government bond yields of eight European Monetary Union countries and up to eleven different maturities. In identifying this impact, it adopts a novel econometric approach that combines data-rich dynamic factor analysis and VAR with heteroskadasiticy based identification. This novel approach allows a single model to estimate the impact of a common unconventional monetary policy shock across different countries, maturities, yield components and over time. The results identify a significant and substantial impact for all countries and all maturities in the sample. The evidence also suggests that the impact was stronger and persistent in the periphery countries which have higher financial distress, uncertainty, country risk and lower liquidity. When we decompose the impact into separate yield components, we find that unconventional shocks decreased the common market component of the yields in all countries. As for the risk component, unconventional policies decreased it for the periphery countries permanently at the cost of a small increase in the core countries, as consistent with the international portfolio balance channel. These findings contribute to the literature by providing a comprehensive characterization of the impact of unconventional monetary policies for different economic environments.
The exchange rate is an important part of the transmission mechanism in the determination of monetary policy because movements in the exchange rate have signi…cant e¤ect on the macroeconomy. It can be di¢ cult to measure the reaction of monetary policy to the movements of the exchange rate, due to the simultaneous response of monetary policy to the exchange rate and the possibility that both variables respond to several other variables. This study addresses these problems by using an identi…cation method based on the heteroscedasticity in the high-frequency data. The results in this paper suggest that the ECB systematically responds to exchange rate movements but that quantitative effects are small. Such a signi…cant but small reaction coe¢ cient seems consistent with the hypothesis that the central banks do not target the ‡uctuations in the exchange rate but consider them only to the extent they impact on the expected in ‡ation and output path.JEL codes: E44, E52, G12
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