This paper analyses the international spill-overs of uncertainty shocks originating in the US. We estimate an open economy, structural factor-augmented vector autoregression (FAVAR) model that identifies US uncertainty shocks and estimates the impact of these uncertainty shocks on the US economy, major world economies and a small open economy, namely New Zealand. The data-rich nature of our model allows us to investigate different transmission channels from the US to the rest of the world. We find the confidence channels, measured by the expectations surveys, are particularly important in the transmission of the uncertainty shock to a small open economy.
It has been suggested that the New Zealand economy may have similar characteristics and face similar shocks to some Australian states, so lowering the costs of a trans‐Tasman currency union. We test this, under the assumption that differences in Taylor rule‐implied interest rate paths for different regions give an indication of differences in aggregate shocks that hit different economies. We compare implied Taylor rule interest rates for each of the Australian states to implied Taylor rule rates for New Zealand. We also compare them to realised 90‐day rates. We find that the Taylor rule‐implied rates in Australian states and in New Zealand are similarly correlated with actual Australian interest rates.
We test for evidence of asymmetric behaviour in the monetary policy reaction functions of the central banks of Australia and New Zealand. For the Reserve Bank of New Zealand, we found little evidence of asymmetric behaviour, whereas the Reserve Bank of Australia (RBA) appears to react more aggressively to negative output relative to positive output gaps of the same size. We impose additional structure on our model to help distinguish whether the asymmetric response originates from non‐linearity in the inflation equation or from non‐linearity in an approximate representation of the RBA's preferences over macroeconomic outcomes. We find that the preferences of the RBA may drive the asymmetry: the RBA appears to dislike negative output gaps more than positive output gaps of the same magnitude. We show this generates only a small increase in the conditional mean of inflation that is statistically indistinguishable from the target rate of inflation.
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