Explaining Monetary Spillovers: The Matrix Reloaded

Abstract

Using monetary policy shocks for 7 advanced economy central banks, measured at high frequency, we document the strength and characteristics of interest rate spillovers to 47 advanced and emerging market economies. Our main goal is to assess different channels through which spillovers occur and why some economies' interest rates respond more than others. We find that there is no evidence that spillovers relate to real linkages, such as trade flows. There is some indication that exchange rate regimes influence the extent of spillovers. By far the strongest determinant of interest rate spillovers is financial openness. Economies that have stronger bilateral (and aggregate) financial links with the United States or euro area are susceptible to stronger interest rate spillovers. These effects are much more pronounced at the longer end of the yield curve, indicating that while economies retain policy rate independence, financial conditions are influenced by global yields.

Central Bank Information Shocks and Exchange Rates

“…Their responses highlight the importance of treating foreign variables as endogenous when assessing exchange rate responses to shocks originating in large open economies. Foreign 2-year government bond yields increase on impact by about 40 basis point, in line withKearns, Schrimpf and Xia (2018)'s findings of…”

When is Bad News Good News? U.S. Monetary Policy, Macroeconomic News, and Financial Conditions in Emerging Markets

“…Nonetheless, some studies find a limited role for fundamentals. Eichengreen and Gupta (2015) and Aizenman, Binici and Hutchinson (2016) find that better fundamentals did not insulate EMEs during the taper tantrum, while Kearns, Schrimpf, and Xia (2019) find that macroeconomic variables do not help explain the strength of spillovers from seven advanced economy central banks.…”

THE WORLD ECONOMY: Global outlook overview

“…Evidence for the UK suggests, for instance, that much of the persistent compression in term premia was due because bond market participants correctly inferred that the central bank would pursue an accommodative monetary policy that would keep longer-term yields low Mellina and Macchiarelli, 2020). Given financial markets' integration, a significant amount of the movements observed at the longer end of the yield curve also depends on changes in international risk and uncertainty, as well as monetary policy developments abroad and interest rate spillovers (Kaminska et al, 2015;Kearns et al, 2018). The co-movements in the UK, US and German term premia since 2009 are particularly suggestive of the role of such channels ( figure B3).…”