Abstract
This paper uses the VAR methodology to analyse stock, bond, and exchange rate markets in six Central and Eastern European (CEE) countries. First, we study the influence of shocks occurring in each market on domestic economic conditions. Next, a counterfactual simulation analysis is carried out to discern the role of financial markets in the transmission of European Central Bank (ECB) monetary policy shocks into CEE economies. The results have implications for both present monetary policy-making and future euro adoptions, as well as for investors concerned with financial assets of CEE countries. While examining the estimated responses of domestic output and inflation to changes in stock, bond, and exchange rate prices, we draw conclusions on the relatively lower importance of the bond market and higher importance of stock and exchange rate markets in the economies. The study of transmission channels also points to stock markets as the main channel of transmission, especially in the case of transmission to the output. Transmission of monetary shocks to inflation takes place mainly through stock and exchange rate markets. There is also strong indication on considerable diversity across CEE countries taking place.
Highlights
In an increasingly globalized world, the problem of international spill-over of monetary policy effects that may complicate domestic policy-making and increase the volatility of the real economy has drawn the attention of both policy makers and researchers
It seems plausible that the policy decisions of the European Central Bank (ECB) could significantly affect countries outside the euro area
This paper investigates the importance of three financial markets-the stock market, government bond market, and exchange rate market-in the transmission of euro area monetary policy shocks to Central and Eastern Europe (CEE) countries
Summary
In an increasingly globalized world, the problem of international spill-over of monetary policy effects that may complicate domestic policy-making and increase the volatility of the real economy has drawn the attention of both policy makers and researchers. That would seem especially likely in the case of countries from Central and Eastern Europe (CEE) that joined the European Union within the last decade. Their strong trade and financial ties with the euro area, together with their relatively small size and the openness of their economies, make them plausible examples of strong dependence on foreign (euro area) monetary policy shocks. Of the different possible channels of international monetary shock transmission described in the literature, rapidly integrating financial markets seem to constitute the most probable channel through which transmission of the euro area monetary policy shocks could take place. There is a strong notion about advancing global integration and the development of financial markets through which monetary
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