International Law Pdf Notes
Zoraida
International monetary policy spillovers have been the subject of much economic debate since at least the early interwar period, and formal modeling of monetary policy in an open economy dates back to the pioneering analyses of Mundell (1963) and Fleming (1962).2 These spillovers received renewed attention after the global financial crisis (GFC), when interest rate differentials among different global regions widened substantially and many central banks experimented with new and unconventional forms of monetary stimulus. Notwithstanding several years of very active research, however, most important questions about monetary policy spillovers remain open. Is monetary policy stimulus, for example, "beggar-thy-neighbor" or "boost-thy-neighbor"? Do spillovers from conventional monetary policy actions differ from those of unconventional policies? Are monetary policy spillovers stabilizing or destabilizing for the global economy?
This note presents a broad-brush overview of some of the salient issues on this topic and provides our sense of the answers to some key questions. We start by sketching out a simple framework for understanding how monetary policy actions spill over to other economies. The note then describes some back-of-the-envelope estimates of how U.S. monetary policy actions are transmitted overseas that we corroborate using a large-scale policy model (SIGMA). Finally, we discuss the implications of monetary policy spillovers for global economic stability, including the challenges posed by those spillovers for some countries with multiple policy objectives.
We can identify three distinct channels by which monetary policy actions affect conditions in foreign economies. The first is the exchange rate channel. By way of example, we will consider an easing of monetary policy. This easing should lower the home interest rate relative to foreign rates and depreciate the home currency. This, in turn, boosts the home trade balance, and thus home GDP, while lowering the trade balances and GDP of the country's trading partners. This is a pure expenditure-shifting effect -- that is, it shifts expenditures from foreign countries to the home country. Such an effect is a key feature of the Mundell-Fleming model of international monetary policy interactions, and created the intellectual rationale for the view that monetary policy easing exerted "beggar-thy-neighbor" effects on foreign economies.3
But there are two other channels besides the exchange rate channel, and in the case of a domestic monetary easing, both of these have expenditure-increasing effects on foreign economies. The first is that when monetary policy is eased, this increases domestic demand -- that is, spending on consumption and investment -- in the home country, which increases home-country imports and thus foreign-country exports. This domestic demand channel boosts foreign GDP.
The other channel, which we refer to as the "financial spillovers" channel, arises because when monetary policy is eased, it lowers longer-term yields and raises other asset prices in the home country; this leads, through portfolio balance effects among financially interconnected economies, to capital flows to and lower yields and higher asset prices in foreign economies.4 These easier financial conditions boost domestic spending and thus GDP in foreign countries.
Is monetary policy easing in the home country a negative or a positive on net for economic activity abroad? The answer depends on whether the strength of the negative exchange rate channel is greater or smaller than the combined positive effects of the domestic demand and the financial spillovers channels. And this is fundamentally an empirical question.
This section describes some back-of-the-envelope estimates of the effects on foreign real GDP of U.S. monetary policy actions. These computations are helpful both for understanding the quantitative importance of each of the channels outlined above, and also for interpreting estimates derived from large structural models (as we will show, the estimates from the SIGMA model align quite closely with our rule-of-thumb estimates). We will focus on an (hypothetical) easing of U.S. monetary policy that lowers the 10-year Treasury yield by 25 basis points.5 Our estimates are summarized in Table 1.
Starting with the exchange rate channel, how much does this lower the dollar? Figure 1 focuses on actual monetary policy announcements by the Federal Reserve in the years since the GFC; the x axis represents movements in 10-year Treasury yields from before to after these announcements, while the y axis shows movements in the nominal broad (or multilateral) dollar index. Announcements that lower Treasury yields by 25 basis points are associated with a decline in the dollar of a little less than 1 percent, which is broadly in line with other studies.6
Rounding up, we assume U.S. policy actions that lower the Treasury yield by 25 basis points lower the broad dollar by 1 percent. Based on fairly conventional elasticities implied by an econometric model of U.S. trade used by Federal Reserve Board staff, the decline in the dollar raises U.S. exports by 0.7 percent, lowers U.S. imports by 0.4 percent, and ultimately boosts real net exports by about .15 percent of U.S. GDP after 2-3 years.7 This causes foreign real net exports to deteriorate, pushing down foreign GDP about .05 percent after 2-3 years, a fairly small effect.
We now turn to the second spillover channel, the boost to U.S. domestic demand. Based on earlier studies of monetary policy effects, we assume a 25 basis point decline in the 10-year Treasury yield increases U.S. demand by .5 percent.8 Given that U.S. imports are highly responsive to U.S. activity -- with the elasticity typically estimated to be about 2 -- this expansion in U.S. demand is likely to raise U.S. imports by around 1 percent -- or .15 percent of GDP -- which in turn boosts foreign GDP about .05 percent.9
Finally, we turn to the financial spillovers channel. To help gauge plausible spillover effects, Figure 2 repeats the scatterplot of Fed policy announcements, but now plots German 10-year bund yields on the y axis. It shows that a Fed policy announcement resulting in a 25 basis point reduction in US yields is associated with a 12 basis point reduction in German yields. This estimate is in the neighborhood of estimates by Rogers, et al., (2014) for advanced economies, and by Bowman et al., (2015), for emerging market economies. Rounding this effect to 10 basis points and extrapolating from our U.S. estimates of the effects of interest rates on GDP, we estimate that this should boost foreign GDP by 1/4 percent. We believe this to be a reasonable ballpark estimate, but we caution that estimating financial spillovers remains a very active area of research, and there is no consensus on the strength of this effect.10
Table 1 pulls together the estimates of U.S. spillovers for the three distinct channels. The effects of the exchange rate and the domestic demand channels on foreign GDP are very small. Moreover, they cancel out, leaving the financial spillovers channel as the main factor leading U.S. monetary policy stimulus to boost foreign growth. But, at 1/4 percent, this effect is not very large.
The rules of thumb summarized in Table 1 are incorporated into our large-scale open economy SIGMA model, one of the structural models used by Federal Reserve Board staff for policy simulations. (The Appendix presents an overview of the SIGMA model as well as some details of the SIGMA simulations featured in this note.) SIGMA can be used to trace out the effects of policy actions in global general equilibrium. Figure 3 shows the effects of a persistent easing of U.S. monetary policy that is scaled to reduce the nominal yield on 10-year U.S. Treasury securities by 25 basis points; while foreign monetary policy does not respond to this easing of U.S. monetary policy -- an assumption we'll relax below -- foreign long-term yields fall about 10 basis points due to favorable financial spillovers. Looking at the top left panel, the monetary policy easing raises U.S. GDP by about 0.6 percent above its baseline value (note that all variables are shown as deviations from their baseline paths). Although the dollar falls, as shown in the top right panel, higher domestic demand pushes U.S. imports up on net. All told, foreign GDP rises, as shown in the bottom right, but by roughly half of the rise in U.S. output.
Our estimate of positive spillovers abroad from U.S. policy easing is in line with a number of studies of the cross-border spillover effects of advanced economy monetary policy, but still other studies have found negative spillovers, as Table 2 indicates. This lack of consensus may not be surprising, since the net effect of monetary policy spillovers depends on the relative strength of the three channels involved. In particular, the spillover effects are likely to differ across recipient countries depending on various country-specific features, including how monetary policy reacts, the exchange rate regime, and the degree of vulnerability to external shocks.11 Monetary spillovers may also vary through time, and depend on business cycle conditions.12
As noted above, a significant spur to the renewed interest in monetary policy spillovers of late has been the advent of unconventional monetary policies. Accordingly, much recent research has focused on whether international spillovers differ, depending on whether they stem from conventional or unconventional policy actions. Our own somewhat preliminary analysis suggests that conventional and unconventional U.S. monetary policy actions appear to have similar effects, at least on the dollar and foreign yields. Figure 4 shows that the effects of unconventional policy announcements on the U.S. dollar -- the panel on the left -- don't seem to differ materially from the effects of similar-sized announcements during the pre-crisis period -- the panel on the right. The same holds true for the effects on German bond yields, shown in Figure 5.13 But as shown in Table 3, some studies have found differences in the spillovers from conventional and unconventional policies -- at least for certain asset classes such as equities (e.g., Chen et al. 2014) -- so this issue is far from settled.
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