## section IV) deliver the same results.

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---

### Identification and estimation approach
- Monetary shocks identified through contemporaneous sign restrictions using the procedure developed by Rubio-Ramirez and others (2005).
- Key identifying assumptions:
  - Positive cyclical shock: increases stock prices and bond yields; monetary policy expected to tighten.
  - Positive money shock: increases bond yields and reduces stock prices (arbitrage effect).
  - Both cyclical improvements and tighter monetary conditions assumed to lead to currency appreciation.
- Identification procedure:
  - Generate random draws of orthonormal matrices Q until 1,000 parameterizations satisfying sign restrictions are obtained (set-identified).
  - Select the estimated model whose impulse responses are closest to the median on impact (Fry and Pagan, 2010).
  - Standard deviation across responses used to compute confidence bands.
- Practical notes:
  - Estimating the model without first-differencing considered acceptable because impulse responses revert to steady-state values.
  - The sign restriction on the exchange rate builds on the notion that interest rate parity held for most of the estimation period.

### Baseline impulse-response results (monetary loosening = 1 percentage point decrease in 10-year yield)
- Exchange rate and trade balance responses:
  - Nominal effective exchange rate (NEER) depreciation on impact: of about 4 percent.
  - Trade balance improvement on impact: of near 1 percentage points of GDP.
  - Trade balance impact persistence: averaging 0.7 percent of GDP over the first 24 months.
  - Exchange rate effect relatively short-lived: after 12 months, NEER starts to appreciate.
- Interpretation:
  - Identified structural monetary policy shocks (exogenous component) have contributed significantly to trade balance fluctuations.
  - Exogenous monetary surprises larger in absolute magnitude during the 1990s and early 2000s than during the global financial crisis.
  - Post-crisis years show mostly negative shocks (continuous efforts to stimulate the economy).
- Data characteristics:
  - Choice of a 1 percentage point shock to the 10-year yield is convenient but large relative to the standard deviation for changes to the 10-year rate (about 0.25 percentage points).

### Monetary cycle contributions to trade balance (historical episodes)
- Monetary easing episodes and contributions (average and peak effects):
  - Easing periods:
    - 1994-99: average contribution to net exports ≈ 0.181 percent of GDP; peak (absolute value) ≈ 0.984 percent of GDP.
    - 2006m8-2016m10 (excl. GFC): average contribution to net exports ≈ 0.426 percent of GDP; peak (absolute value) ≈ 0.912 percent of GDP.
  - Tightening periods:
    - 1992m3-1994m11: average contribution ≈ -0.303 percent of GDP; peak (absolute value) ≈ -0.994 percent of GDP.
    - 1999m2-2006m7: average contribution ≈ -0.240 percent of GDP; peak (absolute value) ≈ -0.925 percent of GDP.
- Summary statement:
  - Monetary easing episodes entailed strengthening of the trade balance in the range of [0.2, 0.4] percent of GDP on average, with peak effects near 1 percentage point of GDP.
  - Tightening episodes entailed weakening of the external position in the range of [-0.3, -0.2] percent of GDP on average, with peak effects close to -1 percent of GDP.
- Overall conclusion:
  - On average, monetary policy entails sizable spillovers on trading partners—pointing to greater demand diverting than demand augmenting effects.

### Role of trading partners’ exchange rate regime
- Conceptual expectations:
  - For trading partners with hard fixed exchange rates vs. US dollar: demand-diverting effects mostly muted (stable ER implies no demand diversion); synchronized interest rate movements imply symmetric demand-augmenting effects.
  - For trading partners with flexible exchange rates: demand augmenting and diverting effects should materialize fully.
  - In practice, managed floating regimes blur differences; more heavily managed regimes expected to show smaller demand-diverting effects.
- Empirical design:
  - Trade balance and NEER series constructed for US vis-a-vis 50 largest trading partners (representing 95 percent of total US trade).
  - De facto exchange rate classification based on Ilzetzki, Reinhart and Rogoff (2017) during 2007-10; categories ≥ 10 = de facto flexible, < 10 = de facto fixed.
  - Countries with de facto pegs to currencies other than the US dollar (e.g., Euro area members) classified as flexible regimes.
  - Distinction between advanced economies (AEs) and emerging and developing economies (EMDEs).
- Empirical findings:
  - Trade balance dynamics differ by partner ER regime, especially in post-crisis stimulus period:
    - Rapidly improving trade balance vis-a-vis economies with flexible ERs.
    - Much more gradual/muted improvement vis-a-vis de facto fixed ER regimes.
  - EMDE results (with richer ER variation):
    - Trade balance with flexible ERs reacts markedly to US monetary shocks.
    - Trade balance with rigid regimes displays muted responses (in point estimates and statistical significance).
    - Sizable nominal depreciation vis-a-vis flexible ER group plays a key role in adjustment.
- Implication:
  - Exchange rate movements and associated demand-diverting effects more than offset demand-augmenting effects for trading partners with flexible exchange rates.

### Robustness checks (overview of alternative specifications)
- Variations examined (Table 3):
  - Relax sign restriction on monetary policy effect on NEER (column 2).
    - Result: no material impact on estimates.
  - Use shadow interest rate (Krippner, 2013, 2014) instead of 10-year yield (column 3).
    - Result: qualitative results hold; magnitudes vary (1pp shock to 10-year not directly comparable to 1pp shock in shadow rate).
  - Add risk appetite shocks to refine identification of real shocks (column 4).
    - Result: point estimates somewhat reduced; overall contributions less affected.
  - Remove nominal exchange rate from the model (column 5).
    - Result: very similar to baseline.
  - Specify model with real trade volumes and REER (column 6).
    - Result: impulse responses and contributions somewhat smaller, indicating part of US monetary policy works through terms of trade (prices).
  - Define all variables in real terms (trade volumes, REER, real stock price index (CPI deflated), real 10-year yield) (column 7).
    - Result: qualitative results hold; magnitudes differ from baseline as real and nominal shocks are not directly comparable.
- Selected numeric robustness results (Table 3):
  - Response of Trade Balance to Monetary Shock (IRF) (in percent of GDP)
    - On impact: Baseline -1.00; Unrest. NEER -1.01; Shadow rate -0.31; Risk appetite shock -0.57; Exc. NEER -0.73; Trade volumes + REER -0.71; Real model -0.92
    - After 12 months: Baseline -0.68; Unrest. NEER -0.79; Shadow rate -0.26; Risk appetite shock -0.48; Exc. NEER -0.62; Trade volumes + REER -0.43; Real model -0.51
    - 12 month average: Baseline -0.74; Unrest. NEER -0.84; Shadow rate -0.28; Risk appetite shock -0.47; Exc. NEER -0.64; Trade volumes + REER -0.51; Real model -0.61
  - Contribution to trade balance through money cycle (in percent of GDP)
    - Tightening periods: Baseline -0.26; Unrest. NEER -0.41; Shadow rate -0.04; Risk appetite shock -0.28; Exc. NEER -0.50; Trade volumes + REER -0.18; Real model -0.26
    - Easing periods (excl. GFC): Baseline 0.35; Unrest. NEER 0.42; Shadow rate 0.23; Risk appetite shock 0.40; Exc. NEER 0.35; Trade volumes + REER 0.26; Real model 0.78
- Overall: alternative specifications deliver very similar results to baseline with varying degrees of statistical significance.

### Conventional versus unconventional monetary policy
- Conceptual experiment:
  - CMP (conventional monetary policy) interpreted as operating primarily on the short-end (2-year yield).
  - UMP (unconventional monetary policy) interpreted as operating throughout the curve, captured by shocks to the long-end (10-year yield).
- Estimation strategy:
  - Short-end model: focus on 2-year yield, controlling for 10-year yield; interpret shocks as CMP.
  - Long-end model: focus on 10-year yield; shocks may arise from long-end moves or transmission from short-end (persistent shocks).
  - Estimation period for these exercises: 1992-2007 (pre-crisis) to exclude crisis-period transmission abnormalities and for comparability.
- Findings:
  - Results qualitatively identical for both short- and long-end shocks:
    - Demand augmenting effects operate for de facto pegs.
    - Demand diversion dominates for flexible regimes.
  - Magnitude differences:
    - Larger effects from shocks to long-term rates than from equal-magnitude short-end shocks (long-end movements imply greater monetary shocks).

### Strength of monetary transmission mechanism: pre-crisis vs full sample
- Motivation: post-crisis period potentially characterized by weakened monetary transmission (impaired financial institutions), which could alter spillovers.
- Empirical exercise: estimate baseline model separately for pre-crisis and full sample periods; compare impulse responses.
- Findings:
  - Including post-crisis period shows somewhat larger effect of monetary shocks on the trade balance.
  - Trade spillovers vis-a-vis countries with de facto fixed exchange rate regimes:
    - Strong spillovers in the pre-crisis period.
    - Muted (statistically zero) effects for the full sample.
  - Interpretation: suggestive evidence that monetary transmission functioned differently pre- and post-crisis; post-crisis weaker transmission may have dampened demand-augmenting effects and increased apparent spillovers via demand diversion.
  - Note: estimating model on post-crisis period only (2009-16) yields imprecise estimates due to limited observations.

### Conclusions and policy implications
- Core findings:
  - Monetary policy significantly affects the trade balance, generating trade spillovers to the rest of the world.
  - For the US:
    - Positive monetary shocks → weakening of overall trade balance.
    - Negative monetary shocks → strengthening of overall trade balance.
  - These average effects mostly reflect impacts on trade vis-a-vis partners with de facto flexible exchange rate regimes—demand diverting tends to dominate demand augmenting effects.
- Conventional vs unconventional:
  - Preliminary exploration suggests similar workings for CMP and UMP:
    - Demand augmenting effects for pegged partners; demand diversion dominates for flexible partners.
  - Spillovers may have been larger in the post-crisis period, consistent with a weakened monetary transmission mechanism.
- Caveats and heterogeneity:
  - Results for the US may not be universal; relative importance of demand augmenting vs diverting effects likely varies across countries due to:
    - Type of goods traded (trade elasticities).
    - Degree of trade openness.
    - Strength of the monetary transmission mechanism.
    - Degree of exchange rate pass-through.
- Policy message:
  - Presence of monetary policy spillovers is not an argument against using monetary policy.
  - Appropriate use of monetary instruments can be desirable at both the individual and global level provided recipient economies can use their own interest/exchange rate policy instruments to partially offset spillovers.
  - Simultaneous monetary easing in the US and trading partners mitigates demand-diverting effects while preserving demand-augmenting effects.
  - Coordination may be particularly valuable when countries face the zero lower bound (ZLB).

*Source: IMF Working Paper (section IV) deliver the same results.).*

### section IV) deliver the same results.

### section IV) deliver the same results.

### Identification and estimation approach
- Monetary shocks identified through contemporaneous sign restrictions using the procedure developed by Rubio-Ramirez and others (2005).
- Key identifying assumptions:
  - Positive cyclical shock: increases stock prices and bond yields; monetary policy expected to tighten.
  - Positive money shock: increases bond yields and reduces stock prices (arbitrage effect).
  - Both cyclical improvements and tighter monetary conditions assumed to lead to currency appreciation.
- Identification procedure:
  - Generate random draws of orthonormal matrices Q until 1,000 parameterizations satisfying sign restrictions are obtained (set-identified).
  - Select the estimated model whose impulse responses are closest to the median on impact (Fry and Pagan, 2010).
  - Standard deviation across responses used to compute confidence bands.
- Practical notes:
  - Estimating the model without first-differencing considered acceptable because impulse responses revert to steady-state values.
  - The sign restriction on the exchange rate builds on the notion that interest rate parity held for most of the estimation period.

### Baseline impulse-response results (monetary loosening = 1 percentage point decrease in 10-year yield)
- Exchange rate and trade balance responses:
  - Nominal effective exchange rate (NEER) depreciation on impact: of about 4 percent.
  - Trade balance improvement on impact: of near 1 percentage points of GDP.
  - Trade balance impact persistence: averaging 0.7 percent of GDP over the first 24 months.
  - Exchange rate effect relatively short-lived: after 12 months, NEER starts to appreciate.
- Interpretation:
  - Identified structural monetary policy shocks (exogenous component) have contributed significantly to trade balance fluctuations.
  - Exogenous monetary surprises larger in absolute magnitude during the 1990s and early 2000s than during the global financial crisis.
  - Post-crisis years show mostly negative shocks (continuous efforts to stimulate the economy).
- Data characteristics:
  - Choice of a 1 percentage point shock to the 10-year yield is convenient but large relative to the standard deviation for changes to the 10-year rate (about 0.25 percentage points).

### Monetary cycle contributions to trade balance (historical episodes)
- Monetary easing episodes and contributions (average and peak effects):
  - Easing periods:
    - 1994-99: average contribution to net exports ≈ 0.181 percent of GDP; peak (absolute value) ≈ 0.984 percent of GDP.
    - 2006m8-2016m10 (excl. GFC): average contribution to net exports ≈ 0.426 percent of GDP; peak (absolute value) ≈ 0.912 percent of GDP.
  - Tightening periods:
    - 1992m3-1994m11: average contribution ≈ -0.303 percent of GDP; peak (absolute value) ≈ -0.994 percent of GDP.
    - 1999m2-2006m7: average contribution ≈ -0.240 percent of GDP; peak (absolute value) ≈ -0.925 percent of GDP.
- Summary statement:
  - Monetary easing episodes entailed strengthening of the trade balance in the range of [0.2, 0.4] percent of GDP on average, with peak effects near 1 percentage point of GDP.
  - Tightening episodes entailed weakening of the external position in the range of [-0.3, -0.2] percent of GDP on average, with peak effects close to -1 percent of GDP.
- Overall conclusion:
  - On average, monetary policy entails sizable spillovers on trading partners—pointing to greater demand diverting than demand augmenting effects.

### Role of trading partners’ exchange rate regime
- Conceptual expectations:
  - For trading partners with hard fixed exchange rates vs. US dollar: demand-diverting effects mostly muted (stable ER implies no demand diversion); synchronized interest rate movements imply symmetric demand-augmenting effects.
  - For trading partners with flexible exchange rates: demand augmenting and diverting effects should materialize fully.
  - In practice, managed floating regimes blur differences; more heavily managed regimes expected to show smaller demand-diverting effects.
- Empirical design:
  - Trade balance and NEER series constructed for US vis-a-vis 50 largest trading partners (representing 95 percent of total US trade).
  - De facto exchange rate classification based on Ilzetzki, Reinhart and Rogoff (2017) during 2007-10; categories ≥ 10 = de facto flexible, < 10 = de facto fixed.
  - Countries with de facto pegs to currencies other than the US dollar (e.g., Euro area members) classified as flexible regimes.
  - Distinction between advanced economies (AEs) and emerging and developing economies (EMDEs).
- Empirical findings:
  - Trade balance dynamics differ by partner ER regime, especially in post-crisis stimulus period:
    - Rapidly improving trade balance vis-a-vis economies with flexible ERs.
    - Much more gradual/muted improvement vis-a-vis de facto fixed ER regimes.
  - EMDE results (with richer ER variation):
    - Trade balance with flexible ERs reacts markedly to US monetary shocks.
    - Trade balance with rigid regimes displays muted responses (in point estimates and statistical significance).
    - Sizable nominal depreciation vis-a-vis flexible ER group plays a key role in adjustment.
- Implication:
  - Exchange rate movements and associated demand-diverting effects more than offset demand-augmenting effects for trading partners with flexible exchange rates.

### Robustness checks (overview of alternative specifications)
- Variations examined (Table 3):
  - Relax sign restriction on monetary policy effect on NEER (column 2).
    - Result: no material impact on estimates.
  - Use shadow interest rate (Krippner, 2013, 2014) instead of 10-year yield (column 3).
    - Result: qualitative results hold; magnitudes vary (1pp shock to 10-year not directly comparable to 1pp shock in shadow rate).
  - Add risk appetite shocks to refine identification of real shocks (column 4).
    - Result: point estimates somewhat reduced; overall contributions less affected.
  - Remove nominal exchange rate from the model (column 5).
    - Result: very similar to baseline.
  - Specify model with real trade volumes and REER (column 6).
    - Result: impulse responses and contributions somewhat smaller, indicating part of US monetary policy works through terms of trade (prices).
  - Define all variables in real terms (trade volumes, REER, real stock price index (CPI deflated), real 10-year yield) (column 7).
    - Result: qualitative results hold; magnitudes differ from baseline as real and nominal shocks are not directly comparable.
- Selected numeric robustness results (Table 3):
  - Response of Trade Balance to Monetary Shock (IRF) (in percent of GDP)
    - On impact: Baseline -1.00; Unrest. NEER -1.01; Shadow rate -0.31; Risk appetite shock -0.57; Exc. NEER -0.73; Trade volumes + REER -0.71; Real model -0.92
    - After 12 months: Baseline -0.68; Unrest. NEER -0.79; Shadow rate -0.26; Risk appetite shock -0.48; Exc. NEER -0.62; Trade volumes + REER -0.43; Real model -0.51
    - 12 month average: Baseline -0.74; Unrest. NEER -0.84; Shadow rate -0.28; Risk appetite shock -0.47; Exc. NEER -0.64; Trade volumes + REER -0.51; Real model -0.61
  - Contribution to trade balance through money cycle (in percent of GDP)
    - Tightening periods: Baseline -0.26; Unrest. NEER -0.41; Shadow rate -0.04; Risk appetite shock -0.28; Exc. NEER -0.50; Trade volumes + REER -0.18; Real model -0.26
    - Easing periods (excl. GFC): Baseline 0.35; Unrest. NEER 0.42; Shadow rate 0.23; Risk appetite shock 0.40; Exc. NEER 0.35; Trade volumes + REER 0.26; Real model 0.78
- Overall: alternative specifications deliver very similar results to baseline with varying degrees of statistical significance.

### Conventional versus unconventional monetary policy
- Conceptual experiment:
  - CMP (conventional monetary policy) interpreted as operating primarily on the short-end (2-year yield).
  - UMP (unconventional monetary policy) interpreted as operating throughout the curve, captured by shocks to the long-end (10-year yield).
- Estimation strategy:
  - Short-end model: focus on 2-year yield, controlling for 10-year yield; interpret shocks as CMP.
  - Long-end model: focus on 10-year yield; shocks may arise from long-end moves or transmission from short-end (persistent shocks).
  - Estimation period for these exercises: 1992-2007 (pre-crisis) to exclude crisis-period transmission abnormalities and for comparability.
- Findings:
  - Results qualitatively identical for both short- and long-end shocks:
    - Demand augmenting effects operate for de facto pegs.
    - Demand diversion dominates for flexible regimes.
  - Magnitude differences:
    - Larger effects from shocks to long-term rates than from equal-magnitude short-end shocks (long-end movements imply greater monetary shocks).

### Strength of monetary transmission mechanism: pre-crisis vs full sample
- Motivation: post-crisis period potentially characterized by weakened monetary transmission (impaired financial institutions), which could alter spillovers.
- Empirical exercise: estimate baseline model separately for pre-crisis and full sample periods; compare impulse responses.
- Findings:
  - Including post-crisis period shows somewhat larger effect of monetary shocks on the trade balance.
  - Trade spillovers vis-a-vis countries with de facto fixed exchange rate regimes:
    - Strong spillovers in the pre-crisis period.
    - Muted (statistically zero) effects for the full sample.
  - Interpretation: suggestive evidence that monetary transmission functioned differently pre- and post-crisis; post-crisis weaker transmission may have dampened demand-augmenting effects and increased apparent spillovers via demand diversion.
  - Note: estimating model on post-crisis period only (2009-16) yields imprecise estimates due to limited observations.

### Conclusions and policy implications
- Core findings:
  - Monetary policy significantly affects the trade balance, generating trade spillovers to the rest of the world.
  - For the US:
    - Positive monetary shocks → weakening of overall trade balance.
    - Negative monetary shocks → strengthening of overall trade balance.
  - These average effects mostly reflect impacts on trade vis-a-vis partners with de facto flexible exchange rate regimes—demand diverting tends to dominate demand augmenting effects.
- Conventional vs unconventional:
  - Preliminary exploration suggests similar workings for CMP and UMP:
    - Demand augmenting effects for pegged partners; demand diversion dominates for flexible partners.
  - Spillovers may have been larger in the post-crisis period, consistent with a weakened monetary transmission mechanism.
- Caveats and heterogeneity:
  - Results for the US may not be universal; relative importance of demand augmenting vs diverting effects likely varies across countries due to:
    - Type of goods traded (trade elasticities).
    - Degree of trade openness.
    - Strength of the monetary transmission mechanism.
    - Degree of exchange rate pass-through.
- Policy message:
  - Presence of monetary policy spillovers is not an argument against using monetary policy.
  - Appropriate use of monetary instruments can be desirable at both the individual and global level provided recipient economies can use their own interest/exchange rate policy instruments to partially offset spillovers.
  - Simultaneous monetary easing in the US and trading partners mitigates demand-diverting effects while preserving demand-augmenting effects.
  - Coordination may be particularly valuable when countries face the zero lower bound (ZLB).

*Source: IMF Working Paper (section IV) deliver the same results.).*

### References

### References

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### Appendix figures and notes
- Figure A1. Monetary Policy Rates in Systemic Economies, 2000-15.
- Figure A2. Alternative Classification of Exchange Rate Regimes (response to a 1pp negative monetary shock).
- Data file references shown in source: \\DATA1\RES\Bloomberg\PPT\2016\COsorioBuitron\MP_BTN\MP_paper\R33_M\R33_M.xlsx and \\DATA1\RES\Bloomberg\PPT\2016\COsorioBuitron\MP_BTN\MP_paper\R34_M\R34_M.xlsx.
- Sources: IMF  International Financial Statistics; and authors' calculations.
- Footnote 1/ Includes Argentina, Brazil, Chile, Colombia, China, Czech  Republic, Hungary, India, Indonesia, Korea, Malaysia, Mexico,  New Zealand, Norway, Peru, Philippines, Russia, Sweden, South Africa, Thailand, Turkey.
- Figure A3. Estimated Response to (1pp) UMP Monetary Shock, excluding major countries implementing UMP.
- Data file reference shown in source for Figure A3: \\DATA1\RES\Bloomberg\PPT\2016\COsorioBuitron\MP_BTN\MP_paper\R15_M\R15_M.xlsx  IRF Panel tab.
- Note in Appendix: "Source:authors' estimations." and "1 /  D e  f a c t o  e x ch ange  r a t e r e g ime  cl a s si fi ca t ion b a s ed o n  I M F' s AR E AER.  C oun tr y s a mpl e i n cl udes  E M DE s o nl y."

*Source: wp17142 - References (PDF chapter/section).*

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_Source: https://www.imf.org/-/media/files/publications/wp/2017/wp17142.pdf_