Financial Globalization and Monetary Policy

Abstract

This paper reviews the available evidence and previous research on potential effects of financial globalization, that is, the international integration of financial markets. In particular, we address the questions: Has financial globalization materially increased the influence of external developments on domestic monetary conditions? And, has it reduced the influence of central banks over financial and economic conditions in their own country? We find that central banks with floating currencies retain the ability to independently determine short-term interest rates and thus influence broader financial conditions and macroeconomic performance in their economies. However, domestic financial conditions appear to have become more vulnerable to a wide range of external shocks, complicating the task of making appropriate monetary policy decisions. Moreover, the financial crisis has highlighted the importance of cross-border channels for the transmission of liquidity and credit shocks. With financial transactions increasingly being undertaken in vehicle currencies such as dollars and euros, the liquidity provision and the lender-of-last resort functions of many central banks are being challenged. Accordingly, international arrangements for liquidity provision may become increasingly important in the future.

Spillovers from Us Monetary Policy: Evidence from a Time Varying Parameter Global Vector Auto-Regressive Model

“…They also adjust quickly after the initial decrease. That term spreads behave in a similar fashion could be explained by the high cross-country correlation of short-term rates and bond yields for advanced economies (Kamin, 2013).…”

“…Advanced economies and Latin American countries respond most strongly to the rate increase, whereas Asian currencies tend to be more insulated-a result which is paralleled in their interest rates responses. Again, this could be driven by the comparably low degree of financial openness since this renders exchange rates less sensitive to foreign rate changes (Kamin, 2013). More specifically, in western Europe, exchange rates depreciate as the interest rate differential widens.…”

“…In a survey, Kamin (2013) reviewed the channels through which globalization can shape international responses. In a nutshell, and as pointed out in Mishkin (2009), the effect of more globalization can either enhance or decrease spillovers.…”

“…By the same token, countries with a broad trade base and a high degree of financial market integration reduce the risk of suffering from an adverse shock that originates from a single country. A second observation that was made in Kamin (2013) is that globalization may alter the transmission channels of monetary policy. As trade becomes more important, monetary policy could work more through exchange rates and net exports and less through its effects on domestic demand by steering long-term interest rates.…”

“…With both trade and financial globalization on the rise, the main objective of this paper is to assess whether spillovers are currently different from those in the past and whether such differences can be linked to changes in globalization. These questions have received relatively little attention in the empirical literature on spillovers (for an exception, see Kamin (2013)). This is due to two reasons.…”