Cross-country Transmission Effect of the U.S. Monetary Shock under Global Integration

Monetary policy shocks in the United States are considered a significant cause of economic fluctuations in other countries. We study empirically how the spillover effects of such shocks have changed as a result of the recent deepening of global integration. We consider shocks to the Federal Funds rate and examine how domestic production in a number of advanced, Latin American, and Asian countries were affected by these shocks during the 1990s and 2000s. We show that contractionary U.S. monetary policy shocks reduced domestic production in most of the sampled countries during the 1990s. During the 2000s, by contrast, the adverse effects were moderated. To explore the reasons behind the weakened spillover effects, we construct a DSGE model and examine the theoretical implications of the recent changes in economic structure, including global integration. In addition, we estimate response of trade and financial variables as well as policy instruments to U.S. monetary policy shocks. Our model combined with the empirical exercises suggests that, despite being enhanced by deepened trade integration, spillover effects may be decreasing due to a decline in the relative importance of the U.S. economy, and to regime switches in domestic monetary and exchange rate policy in non-U.S. countries. Though we empirically find a sign of short-run financial contagion during the 2000s, its effect upon the real economy was minor, possibly reflecting its low persistence.