International Transmission of US Monetary Policy Shocks into Open Financial Markets: High-frequency SVAR Approach

Abstract

I investigate the international transmission of U.S. monetary policy shocks into open financial markets. Unlike earlier studies that impose arbitrary relationships on endogenous variables, I use the external instrument approach to identify the impact of U.S. and domestic monetary policy shocks in a structural VAR (SVAR) system. Utilizing the identified shocks for the local projection estimation, I further test non-linear features of such transmission. I find that foreign exchange rates respond to monetary shocks flexibly, i.e., without puzzles raised by earlier studies (e.g., delayed overshooting) and that the shocks strongly propagate into other types of open financial markets as well. I also confirm the significant transmission of domestic monetary shocks in open economies, but U.S. shocks appear to exhibit greater and more persistent influences over domestic asset prices than domestic shocks. Furthermore, the responses of international asset prices show cyclical-dependency and asymmetry in the propagation of U.S. monetary shocks and these findings are broadly consistent across all the open economies studied in this paper. These results imply that U.S. monetary announcements and subsequent reactions of U.S. asset prices play a critical role in international financial markets and this can substantially limit the domestic effects of central banks’ policy actions.