International Financial Crisis: Expectation Transmission and Policy Synchronisation

Abstract

In recent years, the economic and financial linkages of major economies have become intertwined, and the cross-market contagion effect of the global financial crisis has become more apparent. This paper mainly studies the expectation transmission and policy synchronisation in international financial crisis, netting out influence of fundamental-based factors. Contributions of this paper are two folds. First, we innovatively calculate and utilize expectation gap and policy gap. We apply Taylor Rule regression to different expectation and monetary policy stance variables, and uses respective residuals as expectation gap and policy gap. We measure expectation transmission and policy synchronisation by correlation of expectation gap/policy gap between originating economy and affected economies. Second, we innovatively propose financial accelerator in open economy and Taylor Rule augmented by international factors as respective theoretical basis of expectation transmission and policy synchronisation. Our empirical study covers four international financial crises and 24 economies, and finds that expectation transmission and policy synchronisation are generally significant in the four crises. Transmission efficiency varies because of financial openness, financial stability and regional integration. Economic weight of the originating economy also exerts influences. These results convincingly support the theoretical analysis in this paper. Based on above results, this paper proposes relevant policy recommendations, such as to strengthen expectation management, to strike balance between domestic and international equilibrium, and to strengthen international macroeconomic policy coordination.