A comparative assessment of the spillovers of US monetary policy shocks and its mitigation
Introduction
According to the “trilemma” hypothesis (Mundell, 1963), flexible exchange rates enable monetary autonomy under conditions of capital account openness. However, recent empirical studies argue that financial globalization makes the periphery economies (PEs) highly susceptible to the monetary conditions of the center economy (such as the US), irrespective of their exchange rate regimes (Rey, 2016, Rohit et al., 2019). This imposes constraints on the ability of the central banks in the PEs to meet their mandates, which is known as monetary autonomy impairment.
US monetary policy has witnessed shifts in the usage of monetary policy tools with the advent of the Global Financial Crisis (GFC) and the constraints of zero lower bound (ZLB). While Fed Funds Rate (FFR) and Forward Guidance (FG) were predominantly used to maneuver domestic macroeconomic conditions in the pre-ZLB period, the ZLB period saw extensive usages of Large-Scale Asset Purchases (LSAP) and FG. Owing to different objectives and channels of transmission, it is expected that these monetary surprises would have dissimilar spillovers on the PEs. We leverage the work of Swanson (2017)1 and investigate the relative impact of segregated measures of the US monetary policy surprises on monetary autonomy impairment in the PEs.
Further, extant literature has suggested a significant role of macroprudential policies in limiting autonomy impairment(Aizenman et al., 2020). We contribute to this literature by conducting a comparative assessment of the benefits of macroprudential tools against different types of monetary policy surprises in the pre-ZLB and ZLB periods.
We specifically focus on the economies with managed float regime as they attempt to achieve all the three facets of the Mundellian trilemma, i.e., monetary autonomy, capital account openness, and exchange rate stability, partially, thereby, rounding the corners of the “trilemma” (Klein and Shambaugh, 2015). This is in contrast to the economies with freely flexible exchange rates and pegged exchange rates, where autonomy is expected to be complete and non-existent, respectively. Hence, managed float economies present an interesting case to investigate.
Section snippets
Data and methodology
The managed float economies are identified using the de-facto classification of Ilzetzki et al. (2017). This gives us 22 sample economies.2 Our study period includes the years from 2000 to 2015.3
Our estimation is based on the
Results
We estimate Eq. (1) for the pre-ZLB and ZLB periods, which are demarcated by December-2008 when the FFR hit ZLB. For the pre-ZLB period, we use the FFR and the FG shocks, alternatively. On the other hand, for the ZLB period, which did not see any substantive variation in FFR, we include the FG and the LSAP shocks (), alternatively.
In Fig. 1, we present the results of the panel estimation. We also overlay the responses of the US short-term interest rates9
Conclusion
Using disentangled measures of US monetary policy shocks as estimated in Swanson (2017), we find that the LSAP shocks have a far more detrimental impact on the monetary autonomy of managed float economies, as compared to the FFR and the FG shocks. Further, we find macroprudential policies to be quite significant in insulating monetary autonomy, especially against the FFR shocks. Comparing different types of macroprudential policies, we find that the financial institutions-targeted ones are far
Declaration of Competing Interest
The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.
Acknowledgments
We are thankful to the editor, Prof. Pierre-Daniel Sarte and an anonymous referee for extremely helpful comments and suggestions. The study benefited considerably from their expert insights and guidance. We are also thankful to Prof. Eric T. Swanson for helping us with the data on US monetary policy shocks. Any unintended errors or omissions are our own doing. This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.
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