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Has Globalization Changed the International Transmission of U.S. Monetary Policy?

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Maximilian Boeck uses a time-varying parameter vector autoregression to study U.S. monetary policy’s worldwide spillovers as real and financial markets globalize.

Image courtesy of interviewee. February 5, 2024

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The study focuses on how globalization has impacted the international transmission of US monetary policy. It explores two key aspects: the role of the US dollar as a dominant global currency and the significant increase in trade and financial integration since the late 1980s and early 1990s until the Great Financial Crisis.

Key findings include:

1. **Monetary Policy Transmission**: The US dollar significantly influences global trade and financial activities, affecting countries that trade in dollars even if they do not directly engage with the US economy.

2. **Globalization Trends**: Trade and financial integration have risen sharply over the years, leading to anticipated changes in how US monetary policy impacts the global economy. After the financial crisis, however, indicators of trade and financial integration plateaued, potentially leading to reduced or stable effects on international transmission.

3. **Increased Spillovers**: The research highlights that the spillover effects of US monetary policy have increased over time, particularly regarding industrial production and global economic activity.

4. **Channel Investigation**: The study delves into whether trade or financial channels more significantly explain the observed time variations in these effects. Findings suggest that while both channels are crucial, the trade channel plays a more dominant role in accounting for time variations in policy impact.

5. **Policy Implications**: The implications of the research suggest that foreign central banks should consider the changes in spillover effects when designing their policies relative to the Federal Reserve. Conversely, the US Federal Reserve should also acknowledge the reverse spillover effects impacting the US economy when making monetary policy decisions.

Overall, the study highlights the evolving nature of international monetary policy transmission in the context of globalization and emphasizes the importance of both trade and financial channels in understanding this dynamic.

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X-TIMESTAMP-MAP:LOCAL=00:00:00.000,MPEGTS=900000

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The context of our study,

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has globalization changed the international transmission

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of US monetary policy?

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Uh, it's basically that we want to look how the, the process

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of globalization has,

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has changed this international transmission of,

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of US monetary policy.

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So first off, why do we look at, at the US monetary policy,

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and,

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and the reason being that the US dollar is a so-called

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dominant currency around the globe.

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So we could also look for example, at other,

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at other policy actions

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of other central banks like the Euro area with the ECB or,

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or, or,

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at the Japanese n which are also important currencies,

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but they are dominant only in a, in a more local sense.

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For example, in the context of Europe,

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this would be Eastern Europe.

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There the Euro is heavily used in, in trading worlds,

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but the dollar is used internationally,

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both quite heavily in, the denomination of assets

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and liabilities and also in the invoicing of trade.

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And this makes it such an interesting case

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for US monetary policy,

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how the international transmission, works also in a,

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in a, on a global sense, particularly

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because if two, two countries, doing trade

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with each other, invoicing in dollar not necessarily

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involving the us, this can also be affected by US

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monetary policy actions, which does nothing have to do with

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with the US economy itself.

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And the second point is, the process of globalization.

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So how has this changed over time?

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Um, and here our main motivation is that trade

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and financial integration have substantially risen since

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the, since the late eighties

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or early nineties, exactly

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until about the great financial crisis.

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So what we've seen here is a vast increase in,

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in trade integration defined as, exports

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and imports as well, GDP

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and also in financial integration, the same in world GDP

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of, of financial assets.

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Uh, and, and

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therefore we think that this could also drastically alter

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the international transmission effects

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of US monetary policy.

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Uh, and with respect to the last term, what happens

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after the great financial crisis is

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that both these indicators kind of flatten out.

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So in this process, we call usually in economics

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as globalization, so slowing down of the process

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of globalization, and

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therefore we also expect that the effects then get,

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smaller or, or, stay the same in terms of the,

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in terms of the literature.

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But where our, study is,

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is contributing is mainly to two areas.

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Uh, so the first one being the literature on examining the

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international transmission of US monetary policy,

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our contribution years that we look at

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to the time varying dimension of this,

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of this international transmission.

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And the second contribution we have in the papers

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that we also con contribute to the, to the literature,

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which examines already the, time varying dimension

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of US monetary policy.

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But most of these papers

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Focus only exclusively on the US economy

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and do not target, the, the international level.

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So we kind of try to bridge these two literatures.

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Um, and, and there are a couple of papers doing that,

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but what, what we are doing is also, investigating way

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that this financial

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or this trade,

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channel is more important in explaining

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also the time variation.

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So this is our, our main contribution

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with respect to the literature.

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Maybe also a few words on

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what the literature so far has found.

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So there are a myriad

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of papers looking at the international transmission

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of US monetary policy

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or also the international transmission

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of other policy actions of other central banks.

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And they find all, find

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that they have quite substantial internationals below us.

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So in the global integrated world, the,

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the policy actions transmit on a, on a global level, then,

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scholars like, like papers of, of,

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the berry Hong Enrico have showed

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that if we look into this international transmission

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of US monetary policy, how does these effects transmit?

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And usually what these papers find are two broad channels.

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So either be a trade effects, so be a trade

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of US economy itself, be a trade of third country,

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third country trade, not involving theirs also via commodity

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prices or the second channel being,

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the financial channel.

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And, and with respect to this, this second channel,

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I think one should also mention the work of,

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of Helene Ray on the global financial cycle.

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So what, what the idea is that there is a,

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exists a global financial cycle kind of

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representing global risk aversion

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and US monetary policy strongly affecting this global

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risk aversion factor.

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Uh, and it depresses this global risk aversion factor.

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So what what this means is if there's a tightening

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of US monetary policy

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as we have experienced in the last 18 months,

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then global risk aversion is, is going up.

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So investors are less likely to invest more and

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therefore investment is ed.

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And this also has done, ramifications

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for global economic activity

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after the, the description of the model

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and identification of the, of the causal effects.

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Uh, what kind of data are we using in, in the model?

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Uh, and we are using six variables free on the US economy,

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free on the global economy.

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Um, and in terms of the US economy, we are using,

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a short-term interest rate, the federal funds rate extended

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with the shadow rate,

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because we're not interested in, in the effects

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of unconventional monetary policy.

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We have US consumer prices in India,

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and we have also US economic activity as measured

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by industrial production India.

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Um, and in terms of the global variables, we have the rest

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of world industrial production series

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and the rest of world export series as a measure

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of rest of world trade.

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So rest of world here means,

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everything excluding the us.

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And then the last variables is our financial variable,

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which is the global financial cycle variable.

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I was talking earlier about, also in terms

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of these indicators of the rest of world.

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They are coming from the, the global, database

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of global economic indicators from the Federal

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Reserve Bank of Dallas.

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In terms of the results, what, what we are finding is, first

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of all, if we just take a a plain vanilla linear model,

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then we have corroborating evidence

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to the previous literature.

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So we find that a tightening of US monetary policy leads

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to a downturn in US, consumer prices,

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in US economic activity, and also on, on a global level.

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We have a downturn in, rest of world's trade

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and rest of world, economic activity.

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And it depresses the global financial cycl factor.

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So just also, for clarification, rest

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of world here means everything besides the us.

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Um, and when we look at the, at the model

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with the time variation, what we find is

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that these effects grew stronger over time,

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and this holds true for basically

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all the variables in the system.

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So the effects grew stronger over time from the,

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early nineties to the great financial crisis, 2008, 2009.

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So this effects more than double over time.

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Uh, and then afterwards we see a flattening out

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or even a rebound of these effects.

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And what this means is

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that we exactly find in the time wearing parameter framework

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the exact same pattern as we have found in the financial

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and the trade integration series describing

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the process of globalization.

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So we also find this globalization period

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and the globalization period both

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in the data without imposing any additional restrictions.

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Um, and in, in, in con contrasting these,

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these different effects, we find

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that global economic activity and also global trade

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or rest of world to be precise, is, is is

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reacting much more stronger in 2008 than in the beginning

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of the sample in the early nineties.

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And we find also this for the global financial cycling.

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But if we do some significance testing, then we find

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that the, the statistical significance of the differences

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between these two time periods only holds for rest

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of world trade and also for rest of world economic activity,

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but not so for financial, for the financial linkages,

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meaning that the time variation in financial linkages is

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much less pronounced.

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Uh, and from that we start off

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of thinking which channel is actually important

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and driving these time variation.

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Uh, is it a trade channel or is it a financial channel?

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And we cannot conclude this just from this exercise.

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So what we are doing is we also want

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to exploit cross-sectional variation.

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So we have this rest of world economic activity

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or industrial production series, which consists, of,

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of underlying industrial country

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specific contract production series.

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And the Federal Reserve Bank of Dallas gave us the,

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the underlying raw data.

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And we use,

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this country specific industrial production series

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to re-estimate the model 24 times

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for each country respectively.

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And then we can examine,

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which country has strong effects

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or which country has less strong effects.

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And we have some cross-sectional variation which we can

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exploit and this cross-sectional variation.

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Then we relate to this trade

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and financial integration, indicators.

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And what we find is that if we take the average

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of the effects of one country to the financial

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and trade integration series,

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that we find a strong negative relationship,

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meaning a country which is more financially

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or trade integrated, has more negative spillover

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to economic activity to a neg

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to a tightening of monetary policy.

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Uh, so this is basically expected,

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and this corroborates the previous

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findings in the literature.

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But what we can also do is since we have the effects also

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over time, we can also look

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how is the change in the effects related

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to the change in financial and trade integration.

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And what we find here is

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that there's a negative relationship with trade integration

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with the change in trade integration, meaning

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that if there's a stronger change in trade integration over

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time, then there is also a stronger change in

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the spillovers over time.

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But we do not find, as relationship with,

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with financial integration.

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So, what we conclude from this picture is

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that the evidence suggests that trade integration is

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more important in explaining the time variation than

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financial integration,

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or the trade channel and the financial channel.

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Um, but on average, both these channels, trade

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and financial, are indeed important as,

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as has been found in the, in the previous future.

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Um, and then as a last exercise, what we are doing is

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because it could well be

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that the underlying financial multiplier is just time

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varying, and we, and we just do not see

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that there additional spiller was generated

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by the financial linkages.

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Uh, we use the same model

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and identify global financial cycle shock.

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So we shock global financial conditions

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and then examine the outcomes on, on industrial production,

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on rest of all industrial production.

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And what we find here is basically

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a relatively constant effect over time, slowly increasing,

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but relatively constant meaning

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that the financial multiplier has not changed over time.

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And then we can also use this global financial condition

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shock to shut down the transmission mechanism via financial

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linkages in the original baseline model.

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So there we can then basically do a counterfactual

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experiment where to a mon to a tightening

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of monetary policy, we shut down all the transmission via

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financial linkages using this additional shock series.

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Uh, and if we do that, we find

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that there is still time variation left in the rest

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of World Industrial Production series.

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Uh, and therefore, this leads us to conclude

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that the evidence suggests the trade channel is,

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more important in explaining the time

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variation in the financial channel.

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In this paper, what, what we are looking, is

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how globalization has changed international

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transmission of monetary policy.

12:05.345 --> 12:07.965
We investigate this question in a time wearing parameter

12:07.965 --> 12:10.045
framework, and we find that these

12:10.615 --> 12:13.285
spillovers have substantially increased over time,

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specifically on industrial production

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or rest of world industrial production.

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Uh, and in, as soon

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as we investigate which channel is driving these effects,

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so the trade channel

12:24.945 --> 12:27.045
or the financial channel, the evidence suggest

12:27.045 --> 12:30.285
that both channels are important on average,

12:30.985 --> 12:33.565
but just the trade channel is,

12:33.565 --> 12:35.565
explaining the time duration in terms

12:35.565 --> 12:36.805
of policy implications.

12:37.105 --> 12:40.125
Our reach research highlights, two policy implications,

12:40.305 --> 12:43.205
one of the perspective of, foreign central banks,

12:43.505 --> 12:45.245
not the US Central Bank,

12:45.515 --> 12:48.765
that they can tailor their policy actions,

12:49.155 --> 12:51.845
more towards the policy actions of the Federal Reserve.

12:51.895 --> 12:54.965
Since the Federal Reserve has kind of the, the role

12:54.985 --> 12:57.815
of a global banker, and if they know

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that these belows have increased over time due

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to globalization, they can also, mitigate,

13:03.175 --> 13:04.935
additional risk, which may stem from the

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tightening side you're right now.

13:06.915 --> 13:09.495
And also in terms of the Federal Reserve,

13:09.835 --> 13:12.575
the policy implication of our research is that

13:13.435 --> 13:16.775
if the US policy actions generated,

13:16.865 --> 13:20.335
increasing spillovers over time, then some

13:20.335 --> 13:23.495
of the spillovers are also spilling back to the US economy.

13:23.915 --> 13:26.415
So also affecting, again, the US economy.

13:26.515 --> 13:29.295
And also this should be taking into account when conducting

13:29.815 --> 13:30.375
monetary policy.

00:00 - The context of our study, has globalization changed the international transmission of US monetary policy? it's basically that we want to look how the, the process of globalization has, has changed this international transmission of,

00:13 - of US monetary policy. So first off, why do we look at, at the US monetary policy, and, and the reason being that the US dollar is a so-called dominant currency around the globe. So we could also look for example, at other, at other policy actions of other central banks like the Euro area with the ECB or, or, or, at the Japanese n which are also important currencies,

00:38 - but they are dominant only in a, in a more local sense. For example, in the context of Europe, this would be Eastern Europe. There the Euro is heavily used in, in trading worlds, but the dollar is used internationally, both quite heavily in, the denomination of assets and liabilities and also in the invoicing of trade. And this makes it such an interesting case for US monetary policy, how the international transmission, works also in a,

01:07 - in a, on a global sense, particularly because if two, two countries, doing trade with each other, invoicing in dollar not necessarily involving the us, this can also be affected by US monetary policy actions, which does nothing have to do with with the US economy itself. And the second point is, the process of globalization. So how has this changed over time? and here our main motivation is that trade and financial integration have substantially risen since

01:37 - the, since the late eighties or early nineties, exactly until about the great financial crisis. So what we've seen here is a vast increase in, in trade integration defined as, exports and imports as well, GDP and also in financial integration, the same in world GDP of, of financial assets. and, and therefore we think that this could also drastically alter

02:03 - the international transmission effects of US monetary policy. and with respect to the last term, what happens after the great financial crisis is that both these indicators kind of flatten out. So in this process, we call usually in economics as globalization, so slowing down of the process of globalization, and therefore we also expect that the effects then get, smaller or, or, stay the same in terms of the,

02:28 - in terms of the literature. But where our, study is, is contributing is mainly to two areas. so the first one being the literature on examining the international transmission of US monetary policy, our contribution years that we look at to the time varying dimension of this, of this international transmission. And the second contribution we have in the papers that we also con contribute to the, to the literature,

02:51 - which examines already the, time varying dimension of US monetary policy. But most of these papers Focus only exclusively on the US economy and do not target, the, the international level. So we kind of try to bridge these two literatures. and, and there are a couple of papers doing that, but what, what we are doing is also, investigating way that this financial or this trade,

03:17 - channel is more important in explaining also the time variation. So this is our, our main contribution with respect to the literature. Maybe also a few words on what the literature so far has found. So there are a myriad of papers looking at the international transmission of US monetary policy or also the international transmission

03:34 - of other policy actions of other central banks. And they find all, find that they have quite substantial internationals below us. So in the global integrated world, the, the policy actions transmit on a, on a global level, then, scholars like, like papers of, of, the berry Hong Enrico have showed that if we look into this international transmission of US monetary policy, how does these effects transmit? And usually what these papers find are two broad channels.

04:05 - So either be a trade effects, so be a trade of US economy itself, be a trade of third country, third country trade, not involving theirs also via commodity prices or the second channel being, the financial channel. And, and with respect to this, this second channel, I think one should also mention the work of, of Helene Ray on the global financial cycle. So what, what the idea is that there is a, exists a global financial cycle kind of

04:33 - representing global risk aversion and US monetary policy strongly affecting this global risk aversion factor. and it depresses this global risk aversion factor. So what what this means is if there's a tightening of US monetary policy as we have experienced in the last 18 months, then global risk aversion is, is going up. So investors are less likely to invest more and therefore investment is ed.

04:59 - And this also has done, ramifications for global economic activity after the, the description of the model and identification of the, of the causal effects. what kind of data are we using in, in the model? and we are using six variables free on the US economy, free on the global economy. and in terms of the US economy, we are using, a short-term interest rate, the federal funds rate extended with the shadow rate,

05:25 - because we're not interested in, in the effects of unconventional monetary policy. We have US consumer prices in India, and we have also US economic activity as measured by industrial production India. and in terms of the global variables, we have the rest of world industrial production series and the rest of world export series as a measure of rest of world trade. So rest of world here means,

05:49 - everything excluding the us. And then the last variables is our financial variable, which is the global financial cycle variable. I was talking earlier about, also in terms of these indicators of the rest of world. They are coming from the, the global, database of global economic indicators from the Federal Reserve Bank of Dallas. In terms of the results, what, what we are finding is, first of all, if we just take a a plain vanilla linear model,

06:18 - then we have corroborating evidence to the previous literature. So we find that a tightening of US monetary policy leads to a downturn in US, consumer prices, in US economic activity, and also on, on a global level. We have a downturn in, rest of world's trade and rest of world, economic activity. And it depresses the global financial cycl factor. So just also, for clarification, rest of world here means everything besides the us.

06:48 - and when we look at the, at the model with the time variation, what we find is that these effects grew stronger over time, and this holds true for basically all the variables in the system. So the effects grew stronger over time from the, early nineties to the great financial crisis, 2008, 2009. So this effects more than double over time. and then afterwards we see a flattening out or even a rebound of these effects.

07:15 - And what this means is that we exactly find in the time wearing parameter framework the exact same pattern as we have found in the financial and the trade integration series describing the process of globalization. So we also find this globalization period and the globalization period both in the data without imposing any additional restrictions. and in, in, in con contrasting these, these different effects, we find

07:40 - that global economic activity and also global trade or rest of world to be precise, is, is is reacting much more stronger in 2008 than in the beginning of the sample in the early nineties. And we find also this for the global financial cycling. But if we do some significance testing, then we find that the, the statistical significance of the differences between these two time periods only holds for rest of world trade and also for rest of world economic activity, but not so for financial, for the financial linkages,

08:13 - meaning that the time variation in financial linkages is much less pronounced. and from that we start off of thinking which channel is actually important and driving these time variation. is it a trade channel or is it a financial channel? And we cannot conclude this just from this exercise. So what we are doing is we also want to exploit cross-sectional variation. So we have this rest of world economic activity

08:38 - or industrial production series, which consists, of, of underlying industrial country specific contract production series. And the Federal Reserve Bank of Dallas gave us the, the underlying raw data. And we use, this country specific industrial production series to re-estimate the model 24 times for each country respectively. And then we can examine,

09:01 - which country has strong effects or which country has less strong effects. And we have some cross-sectional variation which we can exploit and this cross-sectional variation. Then we relate to this trade and financial integration, indicators. And what we find is that if we take the average of the effects of one country to the financial and trade integration series, that we find a strong negative relationship,

09:24 - meaning a country which is more financially or trade integrated, has more negative spillover to economic activity to a neg to a tightening of monetary policy. so this is basically expected, and this corroborates the previous findings in the literature. But what we can also do is since we have the effects also over time, we can also look how is the change in the effects related

09:51 - to the change in financial and trade integration. And what we find here is that there's a negative relationship with trade integration with the change in trade integration, meaning that if there's a stronger change in trade integration over time, then there is also a stronger change in the spillovers over time. But we do not find, as relationship with, with financial integration. So, what we conclude from this picture is

10:18 - that the evidence suggests that trade integration is more important in explaining the time variation than financial integration, or the trade channel and the financial channel. but on average, both these channels, trade and financial, are indeed important as, as has been found in the, in the previous future. and then as a last exercise, what we are doing is because it could well be that the underlying financial multiplier is just time

10:47 - varying, and we, and we just do not see that there additional spiller was generated by the financial linkages. we use the same model and identify global financial cycle shock. So we shock global financial conditions and then examine the outcomes on, on industrial production, on rest of all industrial production. And what we find here is basically a relatively constant effect over time, slowly increasing,

11:11 - but relatively constant meaning that the financial multiplier has not changed over time. And then we can also use this global financial condition shock to shut down the transmission mechanism via financial linkages in the original baseline model. So there we can then basically do a counterfactual experiment where to a mon to a tightening of monetary policy, we shut down all the transmission via financial linkages using this additional shock series. and if we do that, we find

11:43 - that there is still time variation left in the rest of World Industrial Production series. and therefore, this leads us to conclude that the evidence suggests the trade channel is, more important in explaining the time variation in the financial channel. In this paper, what, what we are looking, is how globalization has changed international transmission of monetary policy. We investigate this question in a time wearing parameter

12:07 - framework, and we find that these spillovers have substantially increased over time, specifically on industrial production or rest of world industrial production. and in, as soon as we investigate which channel is driving these effects, so the trade channel or the financial channel, the evidence suggest that both channels are important on average, but just the trade channel is,

12:33 - explaining the time duration in terms of policy implications. Our reach research highlights, two policy implications, one of the perspective of, foreign central banks, not the US Central Bank, that they can tailor their policy actions, more towards the policy actions of the Federal Reserve. Since the Federal Reserve has kind of the, the role of a global banker, and if they know that these belows have increased over time due

12:59 - to globalization, they can also, mitigate, additional risk, which may stem from the tightening side you're right now. And also in terms of the Federal Reserve, the policy implication of our research is that if the US policy actions generated, increasing spillovers over time, then some of the spillovers are also spilling back to the US economy. So also affecting, again, the US economy. And also this should be taking into account when conducting

13:29 - monetary policy.

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