Abstract
This paper analyses the international transmission of US monetary policy shocks. We use a time-varying, factor-augmented VAR framework to examine how and to what extent the propagation of US policy shocks affects the South East Asian (SEA) and European Union (EU) economies, through various transmission channels. We find that in the SEA economies, the income absorption effect is the most pronounced channel as indicated by the significant worsening of the trade balance of these countries, which provokes a reduction in their output. In addition, wealth effects and the balance sheet channel have an important contribution in the transmission of the shock to these economies. In the EU, the initial rise observed in output as a result of the shock is driven more by exchange rate movements rather than movements in the trade balance. In terms of changes in the magnitude of the effect of the shock over time, we find that the deepening of global integration dampens the effect of the shock on the foreign economies in core macroeconomic and financial variables. Moreover, the impact of the shock on the foreign economies has increased in the post-crisis period.
Highlights
In recent statements, the Federal Reserve (FED) announced that in the near future it will start raising short-term interest rates, thereby putting an end to the near-zero borrowing costs that have prevailed since the US financial crisis
The following historical shocks considered are: (a) 1987—this reference year is often seen as the beginning of globalization (Kose et al 2007); it is considered as the less-integrated period while it is indicative as a period characterized by the Great Moderation, a significant decline in the volatility of output and inflation; (b) 1999—this reference year gauges the impacts of the gradual deepening of global integration, works as the benchmark date for the euro area countries and last, denotes the end of the South East Asian financial crisis that started in 1997; (c) 2007—this reference year denotes when the subprime mortgage crisis erupted in the US; (d) 2014—this year could be seen as representative of the post-crisis period
The year 1987 signals the beginning of global integration, the year 1999 is chosen to gauge the impact of the gradual deepening of financial integration, the year 2007 represents the US pre-crisis period, and, the year 2014 is indicative of the US post-crisis period foreign economies in core macroeconomic and financial variables, e.g. GDP, industrial production, private consumption, investment, short-term rates and stock market
Summary
The Federal Reserve (FED) announced that in the near future it will start raising short-term interest rates, thereby putting an end to the near-zero borrowing costs that have prevailed since the US financial crisis. In contrast to the relevant literature (Bernanke et al 2005; Korobilis 2013; Mumtaz and Surico 2009), we add a fourth dimension, namely the trade factor; and this is another distinguishing feature of our study The idea behind this is twofold; first, to use a wide information set that accounts for various trade activity variables and second, to investigate the effects of the shock in individual trade activity indicators such as exchange rates, terms of trade and the trade balance. The Redux model is considered as the successor to the MFD, and it provides applications of the intertemporal model, equipped with sticky prices and/or wage rigidity, to the international transmission of monetary policy Under this model, a rise in the key country’s rate will reduce domestic output and consumption and reduce foreign consumption and foreign output, thereby reducing the world real interest rate, which in turn accommodates worldwide decreases in current consumption.
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