Monetary Policy Shocks Research Articles

THE EFFECTS OF MONETARY POLICY SHOCK: EVIDENCE FROM SYSTEMICALLY IMPORTANT ECONOMIES

In the paper, we explore the effects of monetary policy shock on the economic growth in systemically important countries such as the US, the Euro Area and China and their impact on Ukraine. Thus, the war in Ukraine and the rise of key policy rates by central banks to curb inflation have had a significant negative impact on economic activity. There has been both a significant decrease in trade activity and a slowdown in the services sector growth, which was the main engine of global economic growth at the beginning of 2023. Based on the vector autoregression model results, we demonstrated a slight initial decline of GDP growth with following stabilization in response to the rise of key policy rates in the US. In China, this decline is much bigger and constitutes 11% after the shock. In the Euro Area, we also observe a similar pattern as in the US with an initial decline up to 2% and a further return to equilibrium. Analyzing the results of the forecast error variance decomposition, we should note that GDP fluctuations in systemically significant economies are mainly explained by their own fluctuations. The key policy rate’s contribution ranges from 1% in the US to 11% in China. At the same time, economic growth in China is less vulnerable to inflation fluctuations, in the Eurozone we observe the most sustained one among the considered economies. In addition, the study shows that the key policy rate in the United States has a positive effect on the one in Ukraine.

MONETARY POLICY DYNAMICS IN NIGERIA: EMPIRICAL EVIDENCES FROM BAYESIAN VECTOR AUTOREGRESSION WITH STOCHASTIC VOLATILITY

In this paper, we examine the dynamics of monetary policy in Nigeria with Bayesian approach to a vector autoregression (VAR). We construct and estimate Bayesian Vector Autoregression with Stochastic Volatility (BVAR-SV) model and extract important policy inputs from the model. Nigeria economy is unstable and it is a known fact that changes to monetary policy affects performance of some macroeconomic variables. The BVAR has the ability to capture sudden changes and nonlinearities arising from the interaction among macroeconomic variables and associated shocks. The study uses monthly data during the period 2003M01 till 2023M12 with three macroeconomic variables namely; inflation rate, money supply, and interest rate. A Markov Chain Monte Carlo algorithm that allows for Bayesian estimation and prediction is employed. Results show that there is strong evidence of monetary policy playing a significant role in explaining the dynamics of interest rate while the impulse responses for the variables to a monetary policy shock do change significantly over time. Also, the monetary policy exert less significant influence in terms of money supply and inflation than interest rate in explaining the dynamics in of monetary policy. It is recommended that BVAR should be also be extended to other macroeconomic variables to examine the effects on monetary policy dynamics.

Deciphering the black-box of monetary policy transmission in South Asia

Purpose ─ This study aims to identify the role of the bank capital channel by investigating how monetary policy affects bank lending through its influence on bank equity capital, in the transmission of monetary policy.Method ─ The study employs panel vector autoregression (pVAR) to investigate the complex relationship between monetary policy shocks, bank capital, and lending behavior. Results ─ The main findings are as follows: 1) The study finds evidence of both the bank lending and bank capital channels in South Asia. The analysis reveals a Granger causality between changes in bank capital position and policy rate adjustments, indicating a dynamic interplay between these variables. 2) The findings suggest, although direct effects of capital position changes on bank lending appear negligible, a nuanced examination uncovers the moderating influence of capital position changes on the impact of policy rate fluctuations on lending behavior. 3) The study suggests that healthier banking systems weaken the bank lending channel in South Asia.Implications/Significance ─ The study is significant because it sheds light on the mechanism involved in the interplay between monetary policy, bank capital, and lending, providing valuable insights for policymakers and future research directions.

External financial and monetary policy shocks: Do they matter for Korean macroeconomy?

Given Korea's status as a small, open economy, it exhibits a pronounced sensitivity to external shocks. Consequently, this article seeks to elucidate the impact of external financial and monetary policy shocks on the fluctuation of critical macroeconomic variables within Korea. Employing Bayesian estimation alongside the impulse response function for empirical analysis, the findings reveal that external financial and monetary policy shocks precipitate declines in exports, output, employment, real wages, consumption, investment, and imports. Conversely, these shocks are associated with increases in both the price level and inflation, highlighting the multifaceted effects of external pressures on the domestic economic landscape. Further, through forecast error variance decomposition, this study demonstrates that, relative to shocks stemming from productivity, terms of trade, and real exchange rate variations, external financial and monetary policy shocks exert a considerably milder impact on the fluctuations of Korea's key macroeconomic variables. This insight suggests a potential area for enhancement in the existing Korean literature on this topic, advocating for the integration of these findings to enrich understanding and analysis. In summary, by delving into the nuanced effects of external shocks on Korea's economy, this article contributes valuable perspectives to the discourse, suggesting avenues for further research and policy formulation. The integration of these results into the broader body of Korean economic literature could significantly augment current understandings and interpretations of Korea's economic dynamics in the face of global financial and monetary turbulence.

The asymmetric response of sovereign credit default swaps spreads to risk aversion, investor sentiment and monetary policy shocks

This paper investigates the determinants of sovereign credit default swaps spreads in the case of European countries. More specifically, it purposes to yield insight into how sovereign credit default swaps spreads respond to changes in investor sentiment, risk aversion, and monetary policy shocks during different market states. Using monthly data from May 2009 to December 2021 and running the quantile regression model, we show that risk aversion, investor sentiment and monetary policy affect the sovereign credit risk changes, and their effects vary across countries and markets states. More importantly, Risk aversion and monetary policy display the major asymmetric role in explaining CDS premia. However, limited asymmetric explanatory power is shown for investor sentiment. Furthermore, our findings demonstrate that the recent European debt crisis has significantly shaped the sensitivity of the sovereign credit risk spreads to the studied determinants. The findings of this study are helpful for investors in forecasting sovereign European credit spreads and hedging the countries default risk.

The Specific Impact of Monetary Policy on Macroeconomic Fluctuations

The stability of monetary policy is crucial for overall economic stability, as both excessive tightening and excessive easing may lead to increased economic fluctuations and financial risks. This paper incorporates zero-interest-rate constraints and monetary policy shocks into a general equilibrium model to discuss the specific impact of monetary policy on macroeconomic fluctuations. The study reveals that when the economy reaches the zero lower bound of interest rates, the overall instability and vulnerability of the macroeconomy significantly increase. Even minor shocks can then result in severe fluctuations. In such circumstances, corresponding monetary policies can be employed to maintain the stability of the financial system. Additionally, effective coordination between monetary policy and macroprudential policy should be emphasized to minimize the losses from adverse shocks.

Macroeconomic impacts of monetary and fiscal policy in the euro area in times of shifting policies: A SVAR approach

This paper analyses the impacts of monetary and fiscal policy of the euro area on output and inflation between 2005 and 2022 using a structural vector autoregressive (SVAR) approach. We employ three alternative indicators of monetary policy, alongside government spending and revenue as fiscal variables to estimate the effects across different subperiods. The findings reveal that monetary policy tightening produces a negative and delayed effect on both output and inflation, with the effects differing across alternative monetary policy indicators in terms of duration and magnitude. A fiscal revenue shock is found to be inflationary, whereas a fiscal spending shock initially has a negative effect on growth that later turns positive, but is short-lived. The effects of fiscal policy shocks are more substantial than the effects of monetary policy shocks. The results also suggest that the effects may differ across subperiods, depending on the nature and intensity of the policy shifts.

Debt vulnerabilities and house price responses to external shocks

This paper investigates whether the responses of house prices to external shocks, including US monetary policy and global geopolitical risk shocks vary, depending on country-specific vulnerabilities. We find that the responses of emerging market economies’ housing prices to both US monetary policy shocks and geopolitical risk shocks are higher in magnitude and duration than those of advanced economies. We also demonstrate that emerging market economies’ housing price responses to both shocks are much more robust in more vulnerable economies. In contrast, advanced economies’ responses are relatively less affected by debt level.

Revisiting the Macroeconomic Effects of Monetary Policy Shocks*

This study re‐evaluates the macroeconomic impact of monetary policy shocks in the United States using the proxy‐SVAR approach of Gertler and Karadi (American Economic Journal: Macroeconomics, 2015, 7, 44–76). Despite increased credit costs and the presence of the credit channel, our analysis reveals modest effects on economic activity post‐mid‐1980s. This robust finding holds across various inference methods and sample considerations. A counterfactual analysis within the framework of Bernanke, Gertler, and Gilchrist (1999, Handbook of Macroeconomics, Elsevier) suggests that a stronger response to inflation in monetary policy execution may explain the subdued impact of shocks, offering valuable insights for policy refinement and understanding the dynamics of economic activity.

Bayesian Flexible Local Projections

Abstract We develop a methodology to estimate impulse response functions via Bayesian techniques with the goal of providing a bridge between a linear vector autoregressive specification and a high-order polynomial local projection, namely flexible local projection. We label this methodology Bayesian Flexible Local Projection (BFLP). We assess the properties of BFLP in a Monte Carlo framework considering both linear and non-linear models as data generating processes. We also empirically illustrate how BFLP can be used with standard identification strategies. In particular, we show how to use external instruments to identify the effects of the monetary policy shock in the United States. Furthermore, exploiting the time-varying nature of the impulse response functions based on BFLP, we assess the zero lower bound irrelevance hypothesis and find no strong evidence that monetary policy was less effective in influencing output and inflation during the recent ZLB period.

Effect of conventional and unconventional monetary policy shocks on housing prices in Canada

This paper investigates the relative importance and effect of conventional and unconventional Canadian monetary policy surprises on housing prices. Using a credible approach to identify structural monetary policy shocks in Canada and a comprehensive Bayesian VAR model to analyze their effects on financial and macroeconomic variables, we find that both conventional monetary policy and quantitative easing shocks have a significant and persistent effect on housing prices in Canada. However, the inflationary effect of a quantitative easing shock is more pronounced than that of an easing target monetary policy surprise. Specifically, the peak effect of a 25-basis point expansionary conventional monetary policy shock is a 2.30% increase in real housing prices while a comparable quantitative easing surprise leads to a peak of 4.56% increase in real housing prices. We conclude that expansionary monetary policy in various forms has had significant inflationary effects on Canadian housing prices. But quantitative easing surprises stand out as the most prominent contributory factor to the escalating Canadian real estate price. Quantitative easing impact consistently outweighs the effects of forward guidance and conventional monetary policy shocks.

Identification of the contagion effect in China's financial market uncertainties: A multiscale and dynamic perspective

Uncertainty is a crucial source of financial market volatility. Unlike previous research considering uncertainty from holistic and static viewpoints, we investigate the contagion effect of financial market uncertainties from a combined time-frequency and dynamic perspective. In a data-rich environment, we construct various uncertainty indices for China's financial market based on forecast errors and examine their contagion effect using a combined wavelet transform and network analysis. We also simulate dynamic contagion patterns under three different extreme scenarios, including a short-term liquidity crisis, a medium-term stock market crash and long-term central bank monetary policy shocks. The results indicate that the short-term fluctuations in China's financial market uncertainty exhibit a greater contagion intensity but with limited range. However, long-term uncertainty shocks exhibit a broader scope, but their impact intensity is significantly mitigated. Moreover, the liquidity crisis does not present a wide impact at the early stage, whereas the contagion pattern of the stock market crash shows explosive characteristics.

Monetary policy surprises on the banking sector: The role of the information and pure monetary shocks

This paper analyzes how monetary policy surprises in Chile affects the real and financial sector separating between a pure monetary policy shock and an information shock. Using inter-day movements of futures of interest rate in the banking system, we identify an information shock when labor data is released and a pure monetary policy shock when the central bank reveals their interest rate decision, and their effects are quantified through an external vector autoregression model. Our results suggest that a pure monetary policy shock produce an appreciation of nominal exchange rate, and contractionary effects on the economy. However, an information shock does not necessarily produce adverse effects. This paper contribute to the literature in two dimensions: studying the effect of the main driver behind the central bank announcements, and their transmission to the banking sector and consequently to the real and monetary sector.

China’s Monetary Policy Impacts on Money and Stock Markets

This study investigated the impact of China’s monetary policy on both the money market and stock markets, assuming that non-policy variables would not respond contemporaneously to changes in policy variables. Monetary policy adjustments are swiftly observed in money markets and gradually extend to the stock market. The study examined the effects of monetary policy shocks using three primary instruments: interest rate policy, reserve requirement ratio, and open market operations. Monthly data from 2007 to 2013 were analyzed using vector error correction (VEC) models. The findings suggest a likely presence of long-lasting and stable relationships among monetary policy, the money market, and stock markets. This research holds practical implications for Chinese policymakers, particularly in managing the challenges associated with fluctuation risks linked to high foreign exchange reserves, aiming to achieve autonomy in monetary policy and formulate effective monetary strategies to stimulate economic growth.

The Effect of Global Monetary Policy Changes on the Financial Strategy of International Companies

In the interconnected global economy, the financial strategies of international corporations play a crucial role in navigating the dynamic landscape shaped by various factors, including monetary policies set by central banks worldwide. This narrative explores the intricate interplay between global monetary policy changes and the financial strategies of multinational corporations, investigating how shifts in these policies reverberate across borders, impacting corporate decision-making, risk management, and performance. Over recent decades, significant transformations in monetary policy frameworks have occurred, driven by evolving economic paradigms, financial crises, and geopolitical dynamics. Central banks have deployed a range of tools, from conventional inflation targeting to unconventional measures like quantitative easing, to stabilize economies and stimulate growth. However, the effectiveness and unintended consequences of these policies transcend domestic boundaries, permeating the international financial system and shaping the strategic imperatives of multinational corporations. The impact of global monetary policy changes on international companies' financial strategies is substantial. U.S. monetary policy shocks notably affect foreign firms, especially those with extensive global production linkages and financial constraints. Financial globalization has made domestic financial conditions more vulnerable to external shocks, reinforcing the case for price stability as an optimal monetary rule. The volatility of foreign currency exchange rates significantly affects international budgeting, while multinationals with foreign involvement exhibit lower leverage ratios and rely more on short-term borrowing. One primary channel through which global monetary policy changes influence international companies is by altering financing costs and access to capital. Changes in interest rates and liquidity conditions affect borrowing costs for firms operating across borders, impacting investment decisions, capital allocation, and capital structure optimization. Additionally, these changes induce currency fluctuations and volatility, necessitating robust currency risk management strategies to safeguard revenues and mitigate exchange rate exposure. Furthermore, global monetary policy changes affect asset prices, financial markets, and investor sentiment, shaping the risk-return dynamics faced by international companies. Expansive monetary policies often fuel asset price inflation and influence investment strategies, while abrupt policy shifts can trigger market dislocations and liquidity constraints. Beyond financial markets, monetary policy changes influence macroeconomic variables, such as economic growth, inflation, and trade patterns, shaping international companies' operating environments and strategic decisions. In conclusion, the interconnectedness of global financial markets accentuates the importance of agility, flexibility, and strategic foresight for multinational corporations in navigating the impact of monetary policy changes on their financial strategies and overall performance.

Household Income, Portfolio Choice, and Heterogeneous Consumption Responses to Monetary Policy Shocks

AbstractThis paper quantifies the roles played by income‐level heterogeneity in the response of consumption to monetary policy shocks using U.S. household data. We show empirically that the response of consumption to expansionary monetary policy shocks is larger for high‐income households than for low‐income households. Empirical facts related to household characteristics suggest two channels: the presence of illiquid assets and heterogeneity in government transfers. Motivated by these empirical findings, we develop a model that incorporates illiquid assets and heterogeneity in government transfers to quantify the importance. Simulations based on the model indicate that the presence of illiquid assets, whose return increases in response to expansionary monetary shocks, is essential for explaining the heterogeneous consumption response.

Measuring Monetary Policy Shocks in Emerging Economies: Evidence from India

AbstractIn this paper, we provide a template for constructing monetary policy shocks for emerging economies. Our approach synthesizes financial data with a narrative analysis of central bank communication and related media coverage. We create a publicly available time‐series database of policy dates and shocks for the Reserve Bank of India (RBI). Our shocks suggest that financial markets infer information about the future path of policy rate from RBI communication. Bond and stock markets react strongly to these monetary shocks but exhibit heterogeneity across governor regimes. Finally, we use the shocks as external instruments to identify the impact on macro‐economic variables.

The impact of monetary policy shocks — Do not rule out central bank information effects or economic news

This paper reassesses the impact of monetary policy and central bank information shocks while accounting for the influence of economic news. We regress a set of monetary policy surprises on a measure of economic news and incorporate these new instruments into an SVAR model. Furthermore, we distinguish between the two shocks via sign restrictions on the instruments’ impulse response functions. Our findings indicate significantly stronger and more enduring economic effects for monetary policy shocks, while the economic effects of central bank information shocks are weaker, if not vanish entirely. Nevertheless, persistent financial effects prevent us from completely dismissing the existence of central bank information effects. Consequently, it is important to account for both the effects of central bank information shocks and economic news in monetary policy settings.

Testing the Dimensionality of Policy Shocks

Abstract This paper provides a nonparametric test for deciding the dimensionality of a policy shock as manifest in the abnormal change in asset returns’ stochastic covariance matrix, following the release of a macroeconomic announcement. We use high-frequency data in local windows before and after the event to estimate the covariance jump matrix and then test its rank. We find a one-factor structure in the covariance jump matrix of the yield curve resulting from the Federal Reserve’s monetary policy shocks before the 2007–2009 financial crisis. The dimensionality of policy shocks increased afterwards because of the use of unconventional monetary policy tools.

U.S. monetary policy shocks and bank lending in Latin America: evidence of an international bank lending channel

ABSTRACT We examine the impact of U.S. monetary policy shocks on bank lending in five major Latin American countries where large U.S. banks have limited presence. Our analysis covers annual balance sheet data from 2000 to 2021 for all banks in these nations, utilizing a recently developed measure of U.S. monetary policy shocks by Bu et al. Our findings reveal the existence of an international bank lending channel, with a one-percentage-point increase in the Fed funds rate resulting in an average 80.6 basis-point reduction in domestic bank loan growth in these countries. Liquidity and solvency emerge as crucial factors driving variations in lending behaviour among Latin American banks, with banks exhibiting stronger liquidity and solvency profiles experiencing higher loan supply growth rates.