The transmission of U.S. monetary policy to small open economies

Abstract

This paper studies the transmission of a U.S. monetary policy tightening to a set of small open economies. It uses as policy instruments Wu and Xia (2016) shadow rate, the Fed funds rate (conventional monetary policy, CMP) and changes in the Fed balance sheet (unconventional monetary policy, UMP). The main findings include: (1) the shock always reduces foreign economic activity and contributes to the emergence of a “global” financial cycle. (2) The financial channel has become more important since 2008. 3) There is evidence of an oil transmission channel. (4) Cross-country differences do not depend on their international trade volume, exchange rate flexibility or financial openness. U.S. policymakers may need to consider the feedback effects of changes in their policy stance on world demand and inflation. Small open economies should assess the type of U.S. monetary policy shock to evaluate the channels through which their economies may be affected.