|
|
|
| Cross-country Heterogeneity of the Impact of US Contractionary Monetary Policy |
| MEI Dongzhou, SONG Jiaxin, MA Zhenyu
|
School of International Trade and Economics, Central University of Finance and Economics;
School of Finance, Capital University of Economics and Business |
|
|
|
Abstract The US Federal Reserve (Fed) has raised interest rates frequently since 2021, leading to the tightening of global liquidity and more challenges for global macroeconomic stability. This has provoked concerns among academics and policymakers about the spillover effects of US monetary policies. This paper explores the channels through which these contractionary monetary policy spillovers affect other countries' macroeconomics, particularly which factors amplify the impact of the policy during the process of transmission.
This paper first collects quarterly data for 44 advanced and emerging economies and then uses the local projection method to identify factors that may affect the spillover effects of the US contractionary monetary policy. The results show that when a country has greater financial openness, more financial frictions, stronger procyclical capital flows, and uses a fixed exchange rate regime, the negative impact of spillovers from the Fed's contractionary monetary policy on the country's macroeconomy is strengthened, while the impact of trade openness is not significant.
Based on the identified factors, this paper subsequently constructs a multisectoral open macroeconomic model to examine the transmission channel and amplification mechanism of the US contractionary monetary policy shock. The results show that tightening US monetary policy increases interest rates worldwide, which directly leads to increases in the domestic benchmark interest rates in other countries. On the one hand, the rate of increase in interest rates is higher under a fixed exchange rate system, leading to higher financing costs for companies. On the other hand, the increase in US interest rates has put pressure on other countries to manage their capital outflows. The higher the level of financial openness, the larger the scale of capital outflows. Following the impact of financial frictions, deposit and loan premiums in the financial market have increased by a large margin and amplified further through the financial accelerator mechanism and the procyclical characteristics of capital flows. As a result, the availability of credit has greatly shrunk, while investments and outputs have spiraled downward. Therefore, under a higher degree of financial openness and financial frictions, a country may experience stronger negative shocks from US monetary policy changes. In addition, considering procyclical cross-border capital flows, economic downturns may increase the country's sovereign risk premium and amplify the effect of external shocks. Compared a managed floating exchange rate regime, the use of a fixed exchange rate regime alleviates monetary mismatches and increase sovereign premiums in financial intermediation sectors. However, the domestic benchmark interest rate increases more significantly; therefore, the real borrowing costs for enterprises are higher, resulting in a more severe negative impact of the US contractionary monetary policy on credit, investments, and output.
This paper makes three contributions to the literature. First, while there are already abundant empirical studies on the heterogeneity of the impact of the Fed's monetary policy spillovers, few studies have been able to consistently incorporate and examine multiple country characteristics using a local projection model. This paper not only incorporates traditional factors, such as exchange rate system and trade openness, but also discusses various novel factors, such as financial openness, financial frictions, and the procyclicality of capital flows, providing innovative conclusions and empirical support for our theoretical model analysis. Second, current discussions of the US monetary policy transmission channels are mostly based on empirical research. Few theoretical studies discuss the roles of different country characteristics in transmitting economic shocks. This paper further constructs an open economy model with multiple financial frictions based on Bernanke et al. (1999) and Iacoviello (2015). In addition, the paper analyzes the amplification effect of the characteristics of different countries on the transmission of external shocks from the Fed's contractionary monetary policy, which provides a benchmark theoretical framework for further research. Third, some theoretical studies of the exchange rate regime and US monetary policy spillover have focused on the exchange rate trade channel, while others have focused on the financial channels. This paper uses a general equilibrium framework to comprehensively consider how the exchange rate system affects the transmission of Fed policy shocks under the joint effect of these two channels. The results supplement and enrich the relevant research.
|
|
Published: 03 August 2023
|
|
|
|
|
|
|
|
