The Global Financial Cycle and Us Monetary Policy in An Interconnected World

Abstract

We assess the international spillovers of US monetary policy with a large-scale global VAR which models the world economy as a network of interdependent countries. An expansionary US monetary policy shock contributes to the emergence of a Global Financial Cycle, which boosts macroeconomic activity worldwide. We also find that economies with floating exchange rate regimes are not fully insulated from US monetary policy shocks and, even though they appear to be relatively less affected by the shocks, the differences in responses across exchange rate regimes are not statistically significant. The role of US monetary policy in driving these macrofinancial spillovers gets even reinforced by the complex network of interactions across countries, to the extent that network effects roughly double the direct impacts of US monetary policy surprises on international equity prices, capital flows, and global growth.

What Goes Around Comes Around: How Large Are Spillbacks From US Monetary Policy?

“…A contractionary US monetary policy shock is accompanied by a rise in the one-year Treasury Bill rate, tightens financial conditions by raising the excess bond premium, increases the VXO, appreciates the dollar NEER, temporarily reduces US industrial production and persistently US consumer prices. Our findings are also consistent with the literature on the spillovers from US monetary policy (see, e.g., Banerjee et al, 2016;Georgiadis, 2016;Dedola et al, 2017;Iacoviello and Navarro, 2019;Vicondoa, 2019;Degasperi et al, 2020;Dees and Galesi, 2021): Rest-of-the-world real activity slows down considerably, essentially mirroring developments in the US.…”

“…15 Brute force alternatives for carrying out counterfactual analysis in VAR models are to set to zero autoregressive parameters after or before estimation (see, for example, Ramey, 1993;Vicondoa, 2019;Degasperi et al, 2020;Dees and Galesi, 2021). However, setting to zero VAR coefficients before estimation implies a mis-specified empirical model and induces biased estimates; in general, the bias is not informative about the strength of the channel that is being shut down (Georgiadis, 2017).…”

The Impact of Global Tensions on the Economic and Financial Cycle in Romania

“…There is also a stream of research that focuses on the global financial cycle (Aldasoro et al, 2020;Boz & Tesar, 2019; Miranda-Agrippino & Rey, 2020a) some of them investigating the impact that mostly US monetary policy has on economies (Dées & Gales, 2019;Miranda-Agrippino & Rey, 2020b).…”

“…On the other hand, the global economy can be seen as a network of complex interdependences among countries (Dées & Gales, 2019) which is another important research feature of postmodern studies. Financial and economic evolutions among countries are therefore interconnected, domestic markets receive the influence of the developments that take place on the major international markets and consequently react to it, especially in times of distress, as it was the case during the recent economic and financial crisis (when researcher started to study more intensely this subject).…”

What Goes Around Comes Around: How Large are Spillbacks from US Monetary Policy?

“…In the context of network effects in the spillovers of US monetary policy Dees and Galesi (2019) compare the impulse responses to a US monetary policy shock in a global VAR model across an unconstrained baseline and an alternative specification in which small open economies' VAR models only include US but no other rest-of-the-world foreign variables, and in which the US VAR model does not include any foreign variable. Dees and Galesi (2019) argue that the difference between the impulse responses of the small open economies' variables across the two specifications of the global VAR model represents the network effects in the spillovers from US monetary policy. In a side note, they remark that the differences in the impulse responses for the US variables represent the spillbacks from US monetary policy.…”