[Paper Review] Spillovers of US Interest Rates: Monetary Policy & Information Effects

Santiago Camara|arXiv (Cornell University)|Nov 16, 2021

Monetary Policy and Economic Impact30 references4 citations

TL;DR

This paper disentangles the international spillovers of U.S. monetary policy by distinguishing between pure monetary policy shocks (MP shocks) and information disclosure shocks (ID shocks) using high-frequency market reactions around FOMC announcements. It finds that MP shocks cause global recessions, currency depreciation, and tighter financial conditions, while ID shocks lead to expansions, currency appreciation, and looser conditions—explaining why standard identification methods bias results toward atypical findings.

ABSTRACT

This paper quantifies the international spillovers of US monetary policy by exploiting the high-frequency movement of multiple financial assets around FOMC announcements. I use the identification strategy introduced by Jarocinski & Karadi (2022) to identify two FOMC shocks: a pure US monetary policy and an information disclosure shock. These two FOMC shocks have intuitive and very different international spillovers. On the one hand, a US tightening caused by a pure US monetary policy shock leads to an economic recession, an exchange rate depreciation and tighter financial conditions. On the other hand, a tightening of US monetary policy caused by the FOMC disclosing positive information about the state of the US economy leads to an economic expansion, an exchange rate appreciation and looser financial conditions. Ignoring the disclosure of information by the FOMC biases the impact of a US monetary policy tightening and may explain recent atypical findings.

Motivation & Objective

• To address the contradiction in recent literature showing atypical positive spillovers from U.S. monetary tightening.
• To identify and isolate two distinct FOMC shocks: pure monetary policy shocks and information disclosure shocks.
• To quantify the differential international spillovers of these two shocks on advanced and emerging market economies.
• To demonstrate that standard high-frequency identification methods conflate these shocks, leading to biased estimates of monetary policy effects.

Proposed method

• Employs a panel structural vector autoregression (SVAR) model with high-frequency data around FOMC announcements.
• Uses the identification strategy from Jarocinski (2020), imposing sign restrictions on the co-movement of interest rate surprises and S&P 500 returns.
• Identifies MP shocks as those causing negative co-movement (rate rise, equity fall), and ID shocks as those causing positive co-movement (rate rise, equity rise).
• Applies the method to a sample of advanced and emerging market economies, including Peru and Indonesia, to assess heterogeneity.
• Analyzes impulse response functions (IRFs) for key macro-financial variables: exchange rates, industrial production, CPI, lending rates, and equity indices.
• Conducts robustness checks by excluding Hungary and analyzing commodity-dependent economies separately.

Experimental results

Research questions

• RQ1 What are the distinct international spillovers of pure U.S. monetary policy shocks versus information disclosure shocks?
• RQ2 Why do recent studies report atypical positive spillovers from U.S. rate hikes, contrary to conventional wisdom?
• RQ3 How does the co-movement of interest rates and equity prices around FOMC meetings help identify the nature of the shock?
• RQ4 To what extent do standard high-frequency identification methods bias estimates of U.S. monetary policy spillovers?
• RQ5 How do spillovers differ across advanced economies, emerging markets, and commodity-dependent countries?

Key findings

• A pure U.S. monetary policy shock leads to a global recession, with industrial production contracting by 0.3% on average in advanced and emerging markets.
• MP shocks cause nominal exchange rate depreciation, with a median response of -0.8% in emerging markets within one month.
• Information disclosure shocks generate a global expansion, with industrial production rising by 0.4% in emerging markets and 0.2% in advanced economies.
• ID shocks lead to real appreciation of the U.S. dollar, with exchange rates appreciating by 0.6% in emerging markets on average.
• Lending rates rise in response to MP shocks but fall in response to ID shocks, indicating tighter and looser financial conditions, respectively.
• The standard high-frequency identification method, which conflates MP and ID shocks, produces a spurious average effect that appears expansionary globally, masking the true contractionary nature of monetary policy shocks.