RDP 2019-03: Explaining Monetary Spillovers: The Matrix Reloaded 7. Conclusion

While it's well established that interest rates co-move across countries, less is known about the economic and financial forces behind this co-movement. Using precisely identified monetary policy shocks for 7 advanced economy central banks, we accurately document the extent of interest rate spillovers to 47 advanced and emerging market economies. The use of high-frequency data is important as it enables us to identify spillovers in a causal sense. While the spillovers from the policy interest rates of the Fed, and even ECB, to other economies' long-term bond yields come less of a surprise, we demonstrate that their monetary policies do not consistently spill over to other economies' short-term interest rates. We also show that spillovers from other major central banks, including the Bank of Japan and Bank of England, are mild at best. Further, in contrast to much of the literature which has focused on spillovers to emerging market economies, we show that the spillovers are actually significantly larger to advanced economies.

To put some structure on why these spillovers occur and some countries' interest rates are more responsive than others we test three possible channels. We study the role of domestic economic conditions, FX regime and bond risk premia (and financial conditions). Using a rich set of bilateral and aggregate economic and financial data, we find that there is no evidence that interest rate spillovers relate to economic linkages across economies. There is some indication that exchange rate regimes influence the extent of spillovers, but 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. While this result is robust across a range of indicators of financial openness, two variables stand out for best representing the financial integration that influences spillover intensity: foreign currency debt denominated in US dollars or euros, and bilateral portfolio equity flows from the United States or euro area.