The Impact of US Monetary Policy and Other External Shocks on the Hong Kong Economy: A Factor-Augmented VAR Approach

Abstract

This paper uses the factor-augmented VAR (FAVAR) framework to study the impact on the Hong Kong economy of the diverging monetary policies by the Fed, ECB and BoJ as well as the Mainland economy slowdown. The empirical results show that changes in US monetary policy mainly affect interest rate-sensitive sectors in Hong Kong; while real variables such as real GDP growth, unemployment rate are more sensitive to the economic slowdown in Mainland China. Monetary easing from the ECB and BoJ to some extent offsets the tightening of the Fed. The transmission channels of external shocks are through trade and capital markets. It is estimated that the combined effect of the four external shocks will on average lower Hong Kong’s quarterly GDP growth by 0.6 percentage points and quarterly inflation by 0.2 percentage points in the first 4 quarters. However, Hong Kong’s financial stability, particularly with regard to loan quality, banks’ capital and liquidity, is well maintained by macro-prudential policies suggesting that Hong Kong’s financial system is resilient to external shocks.