The Growing Impact of US Monetary Policy on Emerging Financial Markets: Evidence from India

Abstract

Much research has been devoted to studying the international spillover effects of US monetary policy. However, a lot of the focus has been on the recent unconventional monetary policies undertaken by the Federal Reserve. Combining high frequency financial market data with a time-varying parameter approach we show that US monetary policy decisions have had significant effects on the Indian stock markets well before the use of unconventional policy tools and that these effects have gotten stronger over time. In addition to the conventional channel of surprise changes in the policy rate, we find that US monetary shocks are also transmitted through an uncertainty channel, which is especially important for announcements about large scale asset purchases (quantitative easing). Using firm level stock prices, we also show that the higher sensitivity of the aggregate response is uniform across the stock market and is not driven by the increased exposure of any specific industry to US monetary policy. Instead, our results suggest that it is driven by the portfolio decisions of foreign institutional investors and the exchange rate becoming more sensitive to US monetary policy.