Financial globalisation, monetary policy spillovers and macro-modelling: Tales from 1001 shocks

Abstract

We hypothesise that New Keynesian DSGE models that do not feature powerful financial spillover channels confound the effects of domestic and foreign disturbances when confronted with the data. We derive several predictions from this hypothesis and subject them to data using monetary policy shock estimates for 29 economies obtained from more than 190 structural monetary models in the literature. Consistent with the predictions from our hypothesis we find that monetary policy shock estimates obtained from New Keynesian DSGE models are in general contaminated by a common component, the more so the more strongly economies are financially integrated in the data. Moreover, we find that the common component is correlated with the actual monetary policy stance of the US and the euro area, again the more so the more strongly economies are financially integrated. This finding is consistent with the hypothesis that in the data Federal Reserve and ECB monetary policies spill over to financial conditions in small open economies through a global and regional financial cycle, but that this is in general not accounted for by the New Keynesian DSGE models used in the literature.