## _cr11203 ## Source details **Canonical URL:** [_cr11203](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11203.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11203.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11203.pdf.json) --- ### SETTING THE SCENE: SIZE AND SOURCES OF U.S. SPILLOVERS - Deepest synchronized world recession since the 1930s was triggered by U.S. shocks via financial channels stemming from underwritten subprime mortgages. - United States accounts for about one-third of both global stock and bond market capitalization, and close to two-thirds of equity and government bond market turnover in the S5. - For most G20 countries, a one percentage point increase in U.S. growth is estimated to raise growth by around half a percentage point; for Canada and Mexico estimated at about four-fifths of a percent (trade channels ~ two-thirds of total). - Financial-market linkages: changes in U.S. bond yields significantly affect yields abroad; equity price changes show larger ratios of spillovers. Event studies of initial financial market responses are effective to assess asset-price linkages. ### BACKGROUND: MAPPING THE LINKAGES — FINANCIAL, TRADE, ASSET PRICE, LIQUIDITY - Direct financial ties: - U.S. net bond debt worth almost 10 percent of global GDP; gross bond liabilities of 13 percent of global GDP. - Foreign presence: net holdings of U.S. bonds exceed 5 percent of GDP in some emerging markets (notably China); foreign banks have about $5.4 trillion of assets in the United States versus U.S. banks’ $2.5 trillion of assets abroad. - U.S. has positive net asset position in equities and FDI; FDI flows increasingly target emerging markets and low income countries. - Trade relationships: - United States accounts for about 11 percent of global trade (exports plus imports). - Exports to NAFTA members account for about 37 percent of total U.S. exports (peak before crisis); U.S. is largest trading partner for Canada and Mexico (~ two-thirds of overall trade in each country in 2010). - Foreign content in U.S. gross exports rose from 9.5 percent in 1995 to 12.3 percent in 2005; China’s contribution to U.S. manufacturing exports' foreign value added rose to more than 11 percent in 2005 (high technology sector FVA from 7 percent in 1995 to about 24 percent in 2005). - Asset price links (10-year U.S. Treasury yield one percentage point rise — pre- and post-crisis): - Pre-crisis: advanced economy bond yields typically rose by 0.4 percentage points; most emerging market dollar bond yields rose by about 0.8 percentage points except China and India. - Post-crisis: rising Treasury yields associated with improvements in global risk appetite, increases in commodity prices, higher equity valuations, and depreciations of the dollar (except vs. low-rate currencies such as the yen). - Key uncertainty: timing of return to pre-crisis asset-price relationships and nature of the “new normal.” - Global liquidity: - U.S. assets dominate collateralized credit markets; U.S. has largest global pension, mutual fund, and insurance industries. - Dollar wholesale funding supported by large money market mutual funds; Treasury guarantee program invoked after a fund “broke the buck.” - Fed swap arrangements extended through August 2012. - Pension and mutual fund outflows from the United States larger and more diversified than inflows; U.S. is a significant net supplier of funds to countries including Brazil, Egypt, and India. ### VIEWS OF OTHER AUTHORITIES ON U.S. POLICY SPILLOVERS - Foreign officials welcomed U.S. policies’ support to global demand but expressed concerns that U.S. systemic policy design could cause capital inflows, spikes in inflation, or hard landings abroad. - Monetary policy viewed as main spillover source: - Some authorities linked ample global liquidity (including QE2) to higher commodity prices and entrenched inflation; others disputed QE2’s role. - Currency strength and capital inflows in some countries partly attributed to QE2; some countries with capital controls reported limited inflows. - Concerns that unwinding QE2 or U.S. rate hikes could trigger damaging capital flow reversals; synchronization of tightening could amplify spillovers. ### MONETARY POLICY: QUANTITATIVE EASING, RATE HIKES, AND SPILLOVERS - Event-study findings: - QE1 announcements produced larger asset-price spillovers than pre-crisis monetary messages; QE2 spillovers generally smaller. - QE1 associated with declines in foreign bond yields, dollar appreciation, and higher U.S. inflation expectations; QE2 not associated with short-term improvement in global financial conditions (VIX, oil, nonoil commodity prices, global equity prices). - Vector autoregressions find QE announcements associated with higher capital inflows to emerging market bond and equity funds; actual Fed purchases did not appear to affect such inflows. - Growth spillovers (model-incorporating event-study linkages): - Pre-crisis: a percentage point change in U.S. bond yields yields larger growth spillovers than generic shocks, mainly via bond yields. - QE1 estimated to have larger growth spillovers than QE2 across many economies. - Forward-looking risks: - Reversal of inflows to emerging markets likely when markets expect near-term monetary tightening. - End of QE2 fully anticipated and likely absorbed; Fed preparation to tighten could cause a jump in Treasury yields and sharper capital outflows from emerging markets. - Emerging market considerations: - Limited market depth increases susceptibility to changing capital flows. - Spillovers depend on exchange rate policies of trading partners and regional differences in exchange rate volatility (lower in Asia and Middle East). ### FISCAL POLICY: STIMULUS, CONSOLIDATION, AND GLOBAL EFFECTS - Long-term effects: - Each percentage point reduction in U.S. general government debt-to-GDP ratio lowers global real interest rates by 3–4 basis points (Selected Issues, Chapter 10). - Macroeconomic simulations: a 10 basis point permanent reduction in global real interest rates boosts foreign potential output by 0.1 percent. - Consolidation helps rebalance global demand by reducing the U.S. current account deficit. - Short-term effects: - Short-term impact of typical pre-crisis fiscal consolidation on foreign activity generally small and sign uncertain. - For close trading partners (Canada, Mexico) short-term losses through trade dominate; same for countries with capital controls (China, India for bond markets). - Historical stimulus effects: - 2009 fiscal stimulus estimated to have provided larger-than-expected support to foreign activity; 2010 package likely had opposite effect. - Market sentiment mattered: 2009 expansion may have lowered foreign bond risk premiums offsetting crowding out; by 2010 effect reversed. - Policy implication: - Gradual, credible U.S. deficit reduction unlikely to have major short-term spillovers and likely provides positive longer-term spillovers via lower bond yields; less credible adjustment could generate generalized short-term output losses. - Senior officials: - Agreed on importance of credible fiscal path to avoid crowding out and global interest-rate tensions; cautious on short-run benefits of consolidation given low credit demand and bond yields. ### FINANCIAL POLICY AND REGULATION: DODD–FRANK, INVESTMENT BANKING, WHOLESALE FUNDING - Dodd–Frank Act (July 2010) key features: - Strengthened Fed consolidated supervision over bank holding companies (includes major U.S.-owned broker-dealers). - Establishes Financial Stability Oversight Council (FSOC) to designate systemic firms. - Fed may lend to systemic nonbanks in extremis; “Volcker rules” separate retail banking from risky proprietary trading; creates resolution mechanism for systemic holding companies. - Wholesale funding and cross-border linkages: - U.S. wholesale funds channeled to global banking via major investment banks and money market mutual funds. - Major U.S.-owned broker-dealers integrated into bank holding companies; several large northern European banks have U.S. operations deeply involved in investment banking. - U.S. wholesale funding disruption (post-Lehman) caused large spillovers; simulations calibrated on cross-border loan data estimate significant foreign funding-cost knock-ons. - Equity co-movements and bank betas: - Pre-crisis only major Swiss banks had betas > one-quarter; post-crisis major U.K., German, French, and Italian banks (especially investment banks) had betas > one-quarter. - Post-crisis typical spillover betas: Swiss ~60 percent; U.K. and German ~50 percent; French ~40 percent; Italian ~30 percent; Spanish ~20 percent. - Regulatory arbitrage and international coordination: - Market responses to U.S. regulatory announcements indicate potential regulatory arbitrage; announcements that hurt U.S. banks often led to opposite excess returns in U.K. and Swiss banks. - U.S. reform aims for international consistency on big-picture issues; regulatory arbitrage necessitates coordination via the Financial Stability Board. - Policy implication: - Strong implementation of Dodd–Frank and coordinated prudential supervision of U.S.-based investment banks (including non-U.S.-owned entities) would help contain spillovers through dollar wholesale funding channels. ### EMPIRICAL EVIDENCE: BOND, EQUITY, AND EXCHANGE-RATE SPILLOVERS - Structural VAR (2000–2009) results: - A one-standard-deviation shock to U.S. 10-year yields (about 12 bps) leads to an increase of between 4 and 8 bps in foreign yields; implied multipliers 0.33 to 0.66. - Outward equity spillover multipliers from U.S. range 0.5 (Japan) to 0.8 (Euro Area and U.K.); shocks from other systemic equity markets have almost no impact on S&P 500. - Pre- versus post-crisis patterns: - Pre-2007: a rise in U.S. bond yields passed through ~70 percent to financially open emerging markets; post-crisis bilateral links dissipated for many EMs. - Advanced economies: pre-crisis one-percentage point rise in U.S. yields → 40 bps rise in European/Korean yields, 15 bps in Japan; largely unchanged post-crisis. - Exchange rates: pre-crisis rising U.S. yields associated with dollar appreciation; post-crisis increases in U.S. yields often led to appreciations in emerging market currencies and in commodity exporters; yen depreciated materially when U.S. yields rose. - Panel regressions for EM spreads (2000q1–2010q2, JP Morgan EMBI stripped spreads): - Push factors (U.S. interest rates, global risk measures) explain over half of variation in spreads. - EM spreads move one-for-one with the U.S. high yield spread. - A 100 basis point decrease in yields on 10-year Treasuries associated with a 60–115 basis point reduction in EM spreads (depending on specification). - Selected regression coefficients (standard errors in parenthesis): 10-year Treasury yields *: 1.152 (0.235); High-yield spread *: 1.005 (0.066); R2 examples: 0.810; 0.868. - Event-study regressions (bank excess returns, CAPM baseline): - January 21, 2010 Obama speech lowered U.S. and most European bank equity prices; negative excess returns larger for Swiss, U.K., German, and French banks than for U.S. banks. - Post-crisis bank betas rose markedly across major European systems relative to pre-crisis. ### MODEL SCENARIOS: MONETARY, FISCAL, SOVEREIGN CRISIS, CAPITAL REQUIREMENTS - Typical monetary stimulus (term premium and equity shocks): - Term premium shocks reduce long-term nominal interest rates by: 3.9 percent in the U.S.; 1.9 to 3.0 percent in other advanced economies; zero to 3.4 percent in emerging economies. - Equity risk premium shocks raise equity prices by: 11.7 percent in the U.S.; 5.6 to 8.9 percent in other advanced economies; zero to 10.2 percent in emerging economies. - Estimated peak output gains: 0.3 percent in the U.S.; 0.1 to 0.3 percent in other advanced economies; around zero to 0.2 percent in emerging economies. - QE1 scenario: - Negative term premium shocks reduce long-term nominal interest rates by 65 basis points in the U.S.; 10 to 27 basis points in other advanced economies; 0 to 100 basis points in emerging economies. - Equity price increases: 11.7 percent in the U.S.; 5.6 to 8.9 percent in other advanced economies. - Estimated peak output gains: 0.4 percent in the U.S.; 0.1 to 0.3 percent in other advanced economies; around zero to 0.4 percent in emerging economies. - QE2 scenario: - Negative term premium shocks reduce long-term nominal interest rates by 20 basis points in the U.S.; 3 to 8 basis points in other advanced economies; zero to 14 basis points in emerging economies. - Equity price increases: 0.8 percent in the U.S.; 0.4 to 0.6 percent in other advanced economies. - Estimated peak output gains: 0.1 percent in the U.S.; close to zero in other advanced economies. - Delayed withdrawal of monetary stimulus (Eggertsson and Woodford (2003) strategy): - Estimated peak output gains in the United States: 0.12 to 1.15 percent depending on duration of the delay. - Weighted average peak output gains: Other advanced economies 0.01 to 0.09 percent; Emerging economies 0.01 to 0.10 percent. - U.S. fiscal spillovers to global financing conditions (annual panel, 41 countries, 1990–2010): - Direct effect of a one percentage point increase in U.S. federal debt ratio on sovereign spreads: about 2 basis points (stronger in emerging markets). - Laubach (2009) pass-through: one percentage point increase in federal debt → about 3 basis points rise in long-term Treasury yields. - Combined/direct-plus-pass-through could imply overall increase in local borrowing costs of some 5 basis points per additional percentage point of U.S. federal debt. - Regression highlights (selected): Federal Debt minus Fed Holdings (% of US GDP): 0.023***; U.S. interest rates (long-term bond): 0.298***; Growth: -0.126***; Observations: 539; R-squared: 0.415. - GIMF and G-20 model fiscal consolidation scenarios: - Projected cumulative fiscal consolidation: 2.5 percent of output (April 2011 WEO fiscal impulse); alternative scenario: long-term nominal interest rate in the U.S. declines by 39 basis points by 2014; estimated cumulative U.S. output loss under alternative scenario: 1.3 percent. - Baseline cumulative output losses (2011–2016): Other advanced economies 0.1 to 1.4 percent; Emerging economies 0.1 to 1.0 percent. - Alternative scenario cumulative effects: Other advanced economies range from -0.5 percent to +0.4 percent; Emerging economies range from -0.2 percent to +0.6 percent. - Sovereign debt crisis scenarios (G-20 model): - Contained U.S. sovereign debt crisis (Scenario 1): U.S. peak output loss 4.4 percent; Other advanced economies 0.5 percent; Emerging economies 0.7 percent. - Contagious sovereign debt crisis (Scenario 2): U.S. 4.9 percent; Other advanced economies 3.6 percent; Emerging economies 3.5 percent. - Global bond/stock collapse plus run on dollar — dollar depreciation (Scenario 3): U.S. 4.6 percent; Other advanced economies 3.5 percent; Emerging economies 3.2 percent. - Global bond/stock stress with flight to quality — dollar appreciation (Scenario 4): U.S. 5.1 percent; Other advanced economies 3.7 percent; Emerging economies 3.7 percent. - U.S. capital adequacy requirement shock: - Binding one percentage point increase in U.S. capital adequacy requirements → baseline calibration 0.12 percent increase in interest-rate spread (MAG (2010)). - Baseline peak output losses: U.S. 0.26 to 0.28 percent; Other advanced economies 0.05 to 0.19 percent; Emerging economies 0.05 to 0.16 percent. - Abstracting from cross-border bank lending channel reduces peak spillovers materially. ### BANKING-SECTOR RISK, TAIL DEPENDENCE, AND DYNAMIC MEASURES - Systemic versus individual solvency risk: - Systemic risk and individual risk peaked in Q1 2009; individual risk declined persistently until end-2009. - Synthetic CDS spreads (from contingent claims analysis) are generally higher than actual CDS spreads due to government guarantees. - Dynamic Dependence Structure (DDS) and multivariate EVT findings: - Cross-border banking-sector linkages increased dramatically during the credit crisis, especially for very large increases of default risk until mid-2009. - Spillover risks waned in first half 2010, stabilized mid-2010, then reemerged toward end-2010 and January 2011 with dependence nearing credit-crisis levels. - Event-study adaptations show U.S. policy announcements (e.g., Volcker Rule) associated with flattening of individual–systemic risk relationship and lower systemic risk in the U.S.; similar patterns in Europe indicating positive cross-border spillovers. - Three periods of relative stability in the individual–systemic risk relationship identified: - (i) Lehman collapse to June 2009; - (ii) July 2009 through announcement of the Volcker rule (January 2010); - (iii) after the announcement of the Volcker rule. ### KEY POLICY CONCLUSIONS AND IMPLICATIONS - The size of the U.S. economy and global dominance of its financial markets create uniquely large policy spillovers, largely through global financial asset-price links. - Clear communication of U.S. policies and a better-defined medium-term fiscal policy framework are warranted to limit adverse spillovers. - Concerns that the end of QE2 would provoke rapid emerging-market capital flow reversal appear overblown; actual purchases had little additional impact beyond announcements. - Emerging market capital flows are more likely to reverse when the Fed signals near-term rate hikes. - Credible, gradual U.S. fiscal consolidation would likely have limited short-term spillovers and substantial longer-term global benefits (raising U.S. national saving, lowering global real interest rates, and reducing imbalances). - Strong implementation of Dodd–Frank and coordinated prudential supervision of U.S.-based investment banks would help contain spillovers from dollar wholesale funding disruptions. *Source: 2011 SPILLOVER REPORT, UNITED STATES — Selected chapters and findings as presented in the supplied PDF content.* ### CONCLUSIONS __________________________________________________________________________________ 25 ### CONCLUSIONS ### SETTING THE SCENE: THE SIZE AND SOURCES OF U.S. SPILLOVERS - The global recession triggered by U.S. shocks confirmed major U.S. spillovers via financial channels stemming from underwritten subprime mortgages in an interconnected U.S. financial system, producing the deepest synchronized world recession since the 1930s. - Standard macroeconomic models, which focus on trade and wealth links, typically report small U.S. growth spillovers because bilateral trade and portfolio links are fairly small for systemic countries. U.S. trade is a major driver of activity only in Canada and Mexico, immediate neighbors, and signatories to NAFTA, as well as the Caribbean and Central America. - U.S. markets are central to global asset pricing: the United States accounts for about one-third of both global stock and bond market capitalization, and close to two-thirds of equity and government bond market turnover in the S5. U.S. financial assets act as bellwethers for global prices; U.S. news is a major driver of foreign asset prices. - Financial market ties are a major conduit of U.S. policy effects abroad. Changes in U.S. bond yields significantly affect yields in other countries, and equity price changes show an even larger ratio of spillovers. Imposing observed correlations between U.S. and foreign asset prices on standard macro models generates larger and more plausible international spillovers. - For most G20 countries, a one percentage point increase in U.S. growth is estimated to raise growth by around half a percentage point, with some three-quarters of the impact coming via asset prices. By contrast, overall Canadian and Mexican growth spillovers are estimated at more like four-fifths of a percent, with trade channels accounting for two-thirds of the total. - The macroeconomic and financial environment matters: forward-looking asset markets mean spillovers depend on the factors prompting a policy change and the environment in which it occurs. Event studies measuring initial financial market responses are a powerful tool to assess potential asset price linkages associated with specific policy decisions. - Senior U.S. officials held mixed views on the size and sources of spillovers: some agreed spillovers travel largely through financial market prices; others emphasized global risk-aversion or lower spillover estimates from standard models. Staff noted that spillover reports aim to support other countries’ analysis of changes to the global environment. ### BACKGROUND: MAPPING THE LINKAGES A. Direct Financial Ties - The pivotal role of dollar markets is reflected in the composition of U.S. net international liabilities, the largest in the world. The United States has massive net bond debt, worth almost 10 percent of global GDP. The net debt ratio has almost doubled since 2000, with foreign official holdings of U.S. Treasuries rising from half to three-quarters of the total. U.S. gross bond liabilities of 13 percent of global GDP comprise about equal quantities of government and private debt, plus a large amount of quasi-government “agency” bonds dominated by Fannie Mae and Freddie Mac. The United States has a positive net asset position in equities and foreign direct investment. - Bilateral portfolio links: - Net holdings of U.S. bonds are over 5 percent of GDP in some major reserve-holding emerging markets—most notably China. - Financial centers such as the United Kingdom hold large amounts of (mainly private) U.S. debt, offset by reciprocal U.S. holdings of foreign assets. - Foreign holdings of U.S. equities and U.S. holdings of foreign equities are both large, especially in advanced economies and the Americas. - U.S. foreign direct investment is large in close neighbors and other English-speaking advanced economies; FDI flows increasingly target emerging markets and low income countries. B. Trade Relationships - The United States plays an important but not predominant role in global trade: U.S. trade is second to Euro area trade in value and only slightly larger than China’s. The U.S. has a relatively low level of exports reflected in a huge trade deficit; U.S. imports are around the same size as those of the Euro area and larger than those of other systemic economies. - Bilateral spillovers from U.S. real activity and competitiveness: - U.S. activity and trade volumes: strongest spillovers on NAFTA countries, Central America, and Asia (estimates adjust for international supply chains). - U.S. activity and the terms of trade: largest spillovers for the Middle East, Africa, and some oil producers via cyclically sensitive commodities such as fuels and metals. - Competitiveness: bilateral effects of dollar fluctuations tend to diminish with distance; dollar appreciation increases output in NAFTA members, parts of Central America, Asia, and parts of South America. C. Asset Price Links - A percentage point rise in the 10-year U.S. Treasury bond yield is associated with significant global market effects that changed over the crisis: - Pre-crisis: advanced economy bond yields typically rose by 0.4 percentage points (larger for Australia and Canada, lower for Japan); most emerging market dollar bond yields rose by about 0.8 percentage points except China and India (capital controls). - Pre-crisis: a nominal depreciation against the dollar of 1–2 percent in financially open economies; little impact on emerging markets with managed exchange rates. - Pre-crisis: fall in commodity prices and little effect on global risk appetite—commodity effect important for commodity-producing emerging markets. - These pre-crisis associations reflected markets interpreting higher U.S. yields as signaling higher U.S. growth prospects and expected monetary tightening, with the dollar typically appreciating. - Post-crisis: rising Treasury yields became associated with better global financial sentiment and capital outflows from the United States—rising U.S. yields associated with improvements in global risk appetite, increases in commodity prices, higher equity valuations, and depreciations of the dollar (except against other low-interest-rate currencies such as the yen). The pre-crisis positive link between Treasury and emerging market yields disappeared. - Key uncertainty: timing of return to more typical asset price relationships and the nature of the “new normal.” Rising U.S. Treasury yields should at some point again indicate future monetary tightening rather than better global sentiment, potentially reversing capital flows back to the United States. D. Global Liquidity - Deep asset and money markets channel liquidity globally and explain the central U.S. role in financial intermediation and the virulence of crisis spillovers: - U.S. assets dominate collateralized credit markets; the short-term nature of secured lending and repo explains difficulties in obtaining term dollar funding as collateral and counterparty risks rose. - The United States has the largest global pension, mutual fund, and insurance industries—this “real money” investor base is central to the U.S. bond-based financing model. - Dollar wholesale funding is boosted by large money market mutual funds, an intrinsically U.S. phenomenon; their systemic role was confirmed by the Treasury’s guarantee program after a fund “broke the buck.” - Strains in dollar funding were partly relieved by swap arrangements between the Fed and other central banks; these swap arrangements were extended through August 2012. - Foreign presence in the U.S. banking system is heavy: foreign banks have some $5.4 trillion of assets in the United States versus U.S. banks’ $2.5 trillion of assets abroad. - Pension and mutual fund outflows from the United States are larger and more diversified than inflows; the United States is also a significant net supplier of funds to countries including Brazil, Egypt, and India. ### MOTIVATION: VIEWS OF OTHER AUTHORITIES ON U.S. POLICY SPILLOVERS - Foreign officials generally welcomed U.S. policies’ support to global demand but were concerned U.S. and other systemic policies were designed to solve domestic problems and could cause problems elsewhere (capital inflows, spikes in inflation, hard landings for foreign growth). - Monetary policy was seen as the main source of spillovers: - Several authorities linked ample global liquidity to higher commodity prices and potential entrenched inflation, sometimes attributing the 2010 easing (“QE2”) as more important than Chinese demand in stoking commodity prices; one country disputed any impact of U.S. monetary policy on commodity prices. - Currency strength and strong capital inflows in some countries were often seen as partly the result of QE2; U.S. monetary policy was described as an important push factor for capital flows alongside pull factors. Some countries with capital account restrictions reported they did not receive massive inflows as a result of QE2. - Concerns existed that unwinding QE2 and/or U.S. policy rate hikes could trigger damaging capital flow reversals as returns picked up in source markets, diverting funds back. Monetary policy synchronization with the United States could exacerbate spillovers if others tightened in response to U.S. tightening. *Source: 2011 SPILLOVER REPORT, UNITED STATES — CONCLUSIONS.* ### 21. Fiscal policies in advanced countries with unsustainable current deficits, including the ### _cr11203 - 21. Fiscal policies in advanced countries with unsustainable current deficits, including the ### Analysis: policy spillovers — overview - Advanced-country fiscal policies, including those in the United States, were described as having raised global tail risks, with concern that a market reassessment of U.S. fiscal sustainability could lead to a rapid deterioration in global financing conditions, capital flows, and possibly the value of the dollar. - Potential immediate channels of transmission: - Global bond yields could rise rapidly if markets demanded higher premiums against fiscal risks (as well as possible inflation concerns). - Other countries could face a sudden stop in capital inflows given increased U.S. financing needs. - Fiscal risks could complicate rebalancing of growth models amid weak foreign demand, volatile currency and capital flows, and doubts about the safety of dollar-denominated foreign assets. ### Financial sector policies and spillover channels - U.S. financial sector policies noted as spillover sources: - Authorities in some countries emphasized the importance of better supervisory cooperation; regulatory and supervisory cooperation may be at least as important as macroeconomic policy coordination if financial channels dominate spillovers. - The Dodd–Frank Act was seen as potentially having spillover effects via regulatory arbitrage, though channels were uncertain; concern was also raised that a commitment to not bail out systemic financial institutions could be disruptive if carried out bluntly or time-inconsistently. - Limited supervision of money market funds (on which many non-U.S. banks depend for wholesale funding) was seen as adding fragility to the global financial system. - Potential spillovers from deleveraging of U.S. financial institutions affected by new losses (for example, on commercial property) were mentioned as a risk. ### A. Monetary Policy: Quantitative Easing and Future Rate Hikes - Key mechanisms and concerns: - Monetary policy acts primarily through financial markets; international asset price linkages normally amplify spillovers, possibly more so when interest rates are very low. - Spillovers from unexpected global asset price shifts reinforce the case for clear communication of future monetary policy intentions. - Event-study and model findings: - Estimated asset price spillovers of QE1 announcements are larger than pre-crisis monetary policy messages, while QE2 announcement spillovers appear generally smaller. - Both QE1 and QE2 announcements were associated with declines in foreign bond yields, but the response was notably larger for QE1. - QE1 produced similar patterns for appreciation in dollar exchange rates and higher U.S. inflation expectations; QE2 announcements do not appear to be associated with a short-term improvement in global financial conditions (VIX, oil and nonoil commodity prices, global equity prices). - Asset price responses were generally similar to pre-crisis monetary policy announcements and significantly different from “typical” post-crisis ones; event studies provide a reasonable, albeit imprecise, estimate of global financial market effects. - Vector autoregressions fitted to weekly data find that quantitative easing announcements were associated with higher capital inflows to emerging market bond and equity funds (Selected Issues, Chapter 8). Actual Fed purchases of securities (i.e., implementation of the announcements) did not appear to affect such inflows. - Growth spillovers: - Growth spillovers from U.S. monetary policy were assessed by incorporating estimated asset price linkages from event studies into macro model simulations. - Pre-crisis spillovers were calculated by incorporating estimated knock-ons between U.S. monetary policy (via U.S. asset prices) and foreign bond yields, equity prices, and exchange rates. Results suggest somewhat larger growth spillovers (per percentage point change in U.S. bond yields) than from the generic shock reported in Section I, with the main channel via bond yields. - Growth spillovers from QE1 announcements are estimated to have been larger than pre-crisis monetary policy spillovers would suggest, and those from QE2 smaller. The ordering holds across a wide range of economies, reflecting more positive international financial market knock-ons estimated for QE1 than for QE2. - Forward-looking risks: - Some reversal of inflows to emerging markets is likely when markets start expecting monetary tightening over the near future. - The end of QE2 was fully anticipated and likely already absorbed by markets; by contrast, when the Fed starts to prepare to tighten policies (including by draining liquidity), it could cause a jump in Treasury yields and sharper capital outflows from emerging markets, particularly if the move was unexpected. - Such a shift would signal smaller interest rate differentials and either greater confidence in the U.S. expansion or rising inflationary pressures. - Emerging market dilemmas: - Limited market depth makes emerging market financial conditions particularly susceptible to changing capital flows. - Spillovers from U.S. monetary policy in any one country depend partly on exchange rate policies elsewhere; benefits (costs) to foreign activity of a dollar appreciation (depreciation) will be amplified if a close trading partner fixes to the dollar. - Exchange rate volatility versus the dollar tends to be regional, with much lower volatility in Asia and the Middle East than in other regions, supported by active currency management and (in some cases) capital controls. - Senior Fed officials’ view: - Qualitatively comfortable with staff views on spillover channels from QE2 but less concerned about capital flow reversals. - Emerging market capital flows seen as mainly involving a structural component rather than a cyclical component that could be reversed; U.S. monetary tightening shouldn’t constitute an untoward shock. - FOMC committed to be as transparent as possible; good communication would make for a smoother exit from the zero bound. ### B. Fiscal Policy: Stimulus and Consolidation - Concerns and analytical approach: - Concerns focused on risks from a loss of market confidence in the U.S. fiscal policy trajectory. - To assess net spillovers from U.S. fiscal policy, staff used a multi-pronged approach combining regression analysis; macroeconomic model simulations allowing for various degrees of credibility and financial linkages; and event studies focusing on the impact of key fiscal policy announcements on the relationship between U.S. Treasury yields and foreign asset prices. - Long-term effects: - Long-term impact of U.S. fiscal consolidation on foreign output is positive as lower U.S. government debt and higher saving reduce global real interest rates. - Staff regression analysis finds that each percentage point reduction in the U.S. general government debt-to-GDP ratio lowers global real interest rates by 3–4 basis points over the long run (Selected Issues, Chapter 10). - Macroeconomic model simulations suggest the long-term boost to foreign potential output from a 10 basis point permanent reduction in global real interest rates is a fairly uniform 0.1 percent. - Consolidation would also help rebalance global demand by reducing the U.S. current account deficit. - Short-term effects: - Short-term impact on foreign activity from a typical pre-crisis fiscal consolidation is estimated to be generally small and its sign uncertain. - General observations for a generic fiscal stimulus: - For close trading partners such as Canada and Mexico, short-term losses through trade generally dominate. This also holds for countries with extensive capital controls, most notably China and (for bond markets) India. - Elsewhere, the net impact is generally small and ambiguous. Using the foreign bond yield and exchange rate co-movements implied by a generic pre-crisis budget announcement, the net impact on output is relatively limited. - Significant implications exist for trade and the composition of demand: net effects on foreign output are small relative to the impact on U.S. output, but conceal significant shifts between external and domestic demand, at least for countries with flexible exchange rates. - Historical stimulus effects: - The 2009 fiscal stimulus is estimated to have led to larger-than-expected support to foreign activity while, if anything, the 2010 package likely had the opposite effect. - Event studies find the estimated spillover from U.S. to foreign bond yields in response to stimulus announcements in 2009 was generally more limited than pre-crisis experiences would suggest. - Illustrative policy simulations of a generic fiscal package generate correspondingly more-positive growth spillovers for 2009; by contrast, relatively strong estimated bond market links after the 2010 stimulus announcement imply less benign spillovers in 2010. - Market sentiment is important: in 2009 U.S. fiscal expansion may have lowered foreign bond risk premiums that offset crowding out from higher U.S. government debt; by 2010 this effect appears to have reversed. - Emphasizes importance of adopting a clear medium-term fiscal framework. - Looking ahead: - A gradual, credible U.S. deficit reduction is unlikely to have major growth spillovers, particularly compared to those from a loss of fiscal credibility. - Measured, well articulated, and credible fiscal consolidation that culminates in a major reduction in U.S. government debt as a ratio to GDP would likely provide positive net spillovers to the rest of the world in the short-run via lower bond yields than otherwise—despite current low levels in the United States and some foreign economies. - A less credible adjustment could generate more generalized short-term output losses abroad. - Gradual consolidation reduces the tail risk of a global bond market event where investors would lose confidence in the United States’ ability to respond decisively to looming fiscal challenges; such a loss in confidence would generate major negative spillovers given the role of U.S. government bond yields as global benchmarks. - Senior officials’ perspective: - Agreed on the importance of a credible fiscal path to avoid crowding out and head-off tensions on U.S. and possibly global interest rates. - Less optimistic on short-run benefits of consolidation, as crowding out was not thought to be currently operative given low credit demand and bond yields. - Cautioned that negative short-run impact (including on foreign economies) from severe and frontloaded U.S. fiscal tightening could plausibly be large. ### C. Financial Policy: Investment banking and the Dodd–Frank Act - Post-Lehman disruptions and oversight flaws: - Disruptions after the Lehman bust created major negative growth spillovers and exposed flaws in U.S. financial oversight that sharply distinguished banks (prudential supervision, special resolution procedures, access to Fed liquidity) from nonbanks (investment banks/broker-dealers) where supervision focused on market conduct and official liquidity/resolution were not available. - In response to wholesale funding chaos after Lehman, access to Fed liquidity support was rapidly widened to include major investment banks, money market funds, and selected foreign central banks. - Wholesale funding linkages: - U.S. wholesale funds are generally channeled to the global banking system via major investment banks as well as money market mutual funds. - Major U.S.-owned broker-dealers (Goldman, Sachs & Co. and Citigroup Global Markets) have become or already were part of bank holding companies; several large northern European banks have U.S. operations deeply involved in investment banking, including Barclays, Credit Suisse, Deutsche Bank, and UBS. - Investment banks connect the global banking system to U.S. securities and wholesale funding, often through more internationalized U.K. markets; their systemic role was confirmed by the Fed’s emergency lending actions during the crisis. - Equity co-movement and banking spillovers: - Wholesale funding uncertainties likely explain why co-movements of major U.S. and European bank equity returns have become much tighter since the crisis. - Banking spillovers are measured using “beta” coefficients estimating how excess equity returns of major foreign commercial and investment banks react to U.S. bank excess returns. - Before the crisis, only the major Swiss banks had a beta of over one-quarter; after the crisis, major U.K., German, French, and Italian banks—especially investment banks—also had betas over one-quarter. - Dependence of European banks on U.S. wholesale funding provides a potential conduit for a European financial shock to affect the rest of the world. *IMF staff analysis as presented in the United States 2011 Spillover Report (Selected Issues references and chapters cited within).* ### 40. Dollar markets stretch well beyond U.S. borders, reinforcing spillovers while limiting ### Dollar markets stretch well beyond U.S. borders, reinforcing spillovers while limiting ### Dollar market reach and cross-border dynamics - Dollar markets extend well beyond U.S. borders, reflecting the global role of the dollar as a reserve currency and liquid store of value. - Pre-crisis regulatory circumvention occurred as investment banks moved trades to less-regulated markets (example: looser U.K. rules on collateral “rehypothecation” drove some prime-brokerage business to London). - Financial centers have complementary strengths: New York’s deep securities markets and London’s derivatives focus and internationalism. - The London inter-bank offered rate (LIBOR) is determined in London and only three of the 16 banks on the panel are U.S.-based. ### Spillovers from U.S. wholesale funding disruption - Significant spillovers are estimated to come from widespread U.S. wholesale funding disruption, as crystallized after Lehman’s failure when counterparty risks jumped on fears of a systemic crisis. - Simulations using data on cross-border loans between U.S. and foreign-based banks were used to calibrate knock-ons from disruptions in U.S. wholesale funding costs on foreign funding costs. - The same model provides estimates of the (potentially significant) growth spillovers of U.S. regulatory capital top-ups for systemic players mandated by the Dodd–Frank Act (Selected Issues, Chapter 12). - In assessing regulatory capital top-up costs, these must be viewed against the gains from greater financial stability. ### U.S. structural response and effects of Dodd–Frank - The Dodd–Frank Act (July 2010) is described as the biggest reform of U.S. financial regulations since the 1930s. - Key features of the Act: - Strengthens the Fed’s consolidated supervisory powers over bank holding companies (which now include all major U.S.-owned broker-dealers) while retaining an element of “deference” to the securities and futures regulators. - Establishes a Financial Stability Oversight Council (FSOC) that permits any financial firm to be designated as systemic and brought under Fed oversight. - The Fed may only lend to systemic nonbanks in extremis. - “Volcker rules” separate retail banking from more risky proprietary trading. - Creates a resolution mechanism for systemic holding companies. - Evidence of impact: - Measures of probability of default based on credit default swap spreads are contaminated by bailout expectations; staff instead gauges insolvency risk from prices of bank equity options (Selected Issues, Chapter 13). - The positive relationship over the crisis between risks to individual banks and systemic risk appears to have flattened after the Act was passed, consistent with containing spillovers. ### Market signals, regulatory arbitrage, and international coordination - President Obama’s January 2010 speech on financial regulation signaled seriousness, provoking negative excess returns on bank equity simultaneously in the United States and much of Europe; this telegraphed expectations of similar regulatory stringency in other jurisdictions. - Market responses to subsequent Dodd–Frank announcements may indicate regulatory arbitrage between the United States and Europe: announcements that increased (decreased) excess returns on major U.S. banks are estimated to have led to oppositely signed excess returns on major U.K. and Swiss banks. - Regulatory coordination is strongest in the commercial banking context; risk exists that U.S. rules push trading activities to less regulated sectors or jurisdictions. - Examples: major European investment banks dissolved their U.S. bank holding companies to avoid higher capital requirements; Volcker rules have led to spin-offs of trading activities to unregulated entities with strong but implicit links to regulated affiliates. - Authorities state U.S. reform is geared toward international consistency on big-picture issues, leaving capital standards to Basel while using systemic surcharges and responsibility fees to augment the framework. - Regulatory arbitrage is recognized as a reality necessitating coordination through the Financial Stability Board. ### Supervisory choices and systemic designation implications - Decisions by the FSOC and proactive supervision by the Fed are critical for international financial stability, given the importance of U.S. wholesale funding for foreign banks and the role of U.S.-based investment banks as conduits. - Council decisions on which institutions to designate as systemic will be key; strong international links strengthen the case for designating all U.S.- and foreign-owned major investment banks as systemic and placing them under Fed umbrella supervision. - Prudential supervision of investment banks with highly malleable balance sheets is a difficult challenge and may test the effectiveness of the FSOC in coordinating across specialized regulators. - Ideally, U.S. rules governing trading and funding activities will be closely synchronized with other major centers—especially the United Kingdom—but in practice synchronization is limited. ### Key conclusions and policy implications - The size of the U.S. economy and the global dominance of its financial markets create uniquely large policy spillovers; these come largely through links associated with global financial asset prices. - Clear communication of U.S. policies and a better-defined medium-term fiscal policy framework are warranted given these spillovers. - Concerns that the end of QE2 could lead to a rapid reversal of emerging market capital flows appear overblown; markets reacted to quantitative easing announcements, with little or no additional impact from actual purchases of assets. The fully anticipated end to QE2 seems unlikely to provoke much market reaction. - Emerging market capital flows are more likely to reverse as it becomes apparent that the Fed will hike rates in the foreseeable future, signaling smaller interest rate differentials and confidence in the U.S. expansion and/or fears about inflation. - A credible plan for a gradual U.S. fiscal consolidation would likely have limited short-term spillovers and substantial longer-term benefits: a gradual and credible consolidation would raise U.S. national saving, lowering global real interest rates and imbalances over the medium-term. Beyond close neighbors, negative spillovers from lower U.S. activity would likely be largely if not completely offset by improved global financial market sentiment given the high level of U.S. government deficits and debt. - The risk of major spillovers from a freeze in dollar wholesale funding reinforces the case for strong implementation of Dodd–Frank rules. Given the central role of U.S.-based (but not necessarily U.S.-owned) investment banks in funneling dollar liquidity to the rest of the world, stronger U.S. prudential supervision of these entities—preferably in concert with supervisors in other major financial centers given the geographic mobility of trading activity—would help contain renewed spillovers through this channel. *Source: IMF 2011 Spillover Report, United States (selected chapters and findings).* ### 52. Overall, U.S. and foreign goals appear better aligned for U.S. fiscal and financial ### _cr11203 - 52. Overall, U.S. and foreign goals appear better aligned for U.S. fiscal and financial ### Key summary findings - U.S. and foreign goals appear better aligned for U.S. fiscal and financial policies than for monetary policies. - Fiscal consolidation and sounder financial regulation help avoid global tail risks; all countries have a stake in successful implementation despite disagreements on pace and details. - Monetary policy is more complex: low short-term interest rates and abundant liquidity increase incentives to take financial risks, producing heterogeneous cross-country effects depending on cyclical position and openness of capital markets. ### International financial spillovers: empirical evidence - Data: end-of-week nominal long-term sovereign bond yields and equity prices, 2000 through 2009, for the United States, the Euro area (German yields; FTSEurofirst 300 for equities), Japan, and the United Kingdom. - Identification: structural VAR with endogenous identification via heteroskedasticity (Rigobon 2003) using volatility regimes (x incrementally increasing from 0.65 to 2). - Measured spillovers as cumulative changes over the 4-week period after a shock. - Bond market shocks: - A typical one-standard-deviation shock to U.S. 10-year yields (about 12 bps) leads to an increase of between 4 and 8 bps in foreign yields. - Implied spillover multipliers: 0.33 to 0.66 (smallest in Japan, largest in the Euro area). - Inward spillovers to U.S. bond yields are tiny. - Equity market shocks: - Outward spillover multipliers from U.S. stock shocks range from 0.5 (in Japan) to 0.8 (in Euro Area and the U.K.). - Shocks from other systemic equity markets have almost no impact on the S&P 500. ### Policy announcement event-study findings - Method: event-study regressions based on a CAPM specification with the United States as the “market”; regression includes post-crisis dummy (from start of 2007) and EVENT dummies for policy announcements. Baseline window: 1-day market response (robust to 2-, 5-, 10-day windows). - Bank excess returns: defined as difference between changes in major bank equity prices and local equity market returns (market assessment of relative bank valuation). - Dodd-Frank / regulatory announcements: - January 21, 2010 Obama speech backing tough banking regulation lowered U.S. and most European bank equity prices; negative excess returns for Swiss, U.K., German, and French banks were larger than for U.S. banks. - Other Dodd-Frank announcements (tighter-than-expected) hurt bank excess returns in core European systems, especially Swiss and U.K. banks—suggesting perceived competitive disadvantage for U.S. banks and potential regulatory arbitrage. - Crisis-driven change in linkages: - Pre-crisis, only the Swiss beta exceeded 25 percent; elsewhere a 1 percent U.S. bank excess return associated with less than ¼ percent abroad. - Post-crisis typical spillover betas: about 60 percent to Swiss banks, 50 percent to U.K. and German banks, and 40, 30, and 20 percent to French, Italian, and Spanish banks, respectively (major increases from pre-crisis betas; statistically significant except for Switzerland and Spain). - For non-European banking systems, post-crisis changes in already small betas are insignificant. ### Fiscal and monetary policy spillovers (bonds and exchange rates) - Regression focus: foreign bond yields and exchange rates regressed on changes in U.S. 10-year yields (plus controls); coefficient on Treasury yields interpreted as market “beta”. - Emerging markets: - Pre-2007, a rise in U.S. bond yields had pass-through of some 70 percent for financially open emerging markets; slightly less for India and Russia; no link for China. - Post-crisis, bilateral links between U.S. yields and emerging markets dissipated. - Advanced economies: - Pre-crisis relationship: a one-percentage point rise in U.S. yields led to a 40 basis point rise in European/Korean yields and a 15 basis point rise in Japanese yields; this relationship remained largely unaffected by the crisis. - Yields of advanced commodity exporters: link to U.S. yields fell from two-thirds to one-half. - Exchange rates: - Pre-crisis: rising U.S. 10-year yields associated with appreciations of the dollar (i.e., depreciations of advanced economies and financially open emerging market currencies) — consistent with expected U.S. monetary tightening. - Post-crisis: increases in U.S. yields led to large appreciations in emerging market currencies (especially financially open ones) and in advanced economy commodity exporters; the yen depreciated by even more against the dollar when U.S. yields rose (reflecting safe-haven / carry-trade roles). - U.S. yields had little impact on dollar exchange rates in advanced Europe and Korea post-crisis. ### Fiscal stimulus vs. quantitative easing: differential global effects - Fiscal stimulus: - Fiscal stimulus typically increases Treasury yields; positive relationships imply higher foreign yields and negative foreign asset spillovers. - The 2009 package appeared to lead to a delinking of European and Korean bond yields (negative spillovers tempered amid financial turmoil). - The 2010 package was accompanied by larger-than-normal increases in foreign yields and appreciations across a range of foreign currencies (larger-than-typical negative asset market spillovers). - Interpretation: in 2009, large risk-premium reductions offset yield increases from higher U.S. debt; in 2010, more orderly markets raised concerns about rising U.S. debt. - Quantitative Easing (QE): - QE operates by lowering Treasury yields; tight positive links to Treasury yields imply positive spillovers to the rest of the world. - QE1: - QE1 announcements and related declines in U.S. bond yields were associated with large reductions in emerging market yields and currency appreciations. - QE2 and post-crisis FOMC meetings without QE: - Post-crisis FOMC meetings without QE announcements have negative coefficients on emerging market bond yields and larger-than-usual currency appreciations — consistent with U.S. growth optimism driving up U.S. yields and capital outflows to emerging markets. - QE2 appears to have had more limited positive impacts on foreign financial conditions than QE1. ### Methodological notes and caveats - Weekly data used to avoid missing data and overlapping trading-hours complications at daily frequency. - China excluded from VAR asset-price spillover estimation due to forming markets and capital controls limiting spillovers (China retained separate treatment in regressions). - Analysis focuses on within-asset-class international linkages; bond yields and equity returns considered separately. - Event-study identification relies on deviations from the “typical” beta response; the crisis induced structural shifts that necessitate pre- and post-crisis comparisons. *INTERNATIONAL MONETARY FUND — UNITED STATES: 2011 Spillover Report – Selected Issues (Approved by Tamim Bayoumi, July 22, 2011).* ### 2.2 and 2.3). These emerging market responses seem to have boosted foreign demand ### U.S. FINANCIAL AND TRADE SPILLOVERS (excerpts) ### II. Market Responses to U.S. QE and Event Regressions - Emerging market responses appear to have boosted foreign demand and capital outflows. - QE2 announcements had more muted effects on foreign markets than QE1 ones. - Table 2.1 (Bank Excess Return Regressions) — selected reported coefficients (standard errors in parenthesis; ** and * denote 1 and 5 percent significance): - Switzerland: .42 (.09)**; .16 (.11); 0.58; .94 (.07)**; -.76 (.16)** - UK: .13 (.05)*; .37 (.08)**; 0.50; .78 (.08)**; -.97 (.27)** - Germany: .23 (.09)*; .27 (.11)**; 0.50 - France: .20 (.06)**; .20 (.07)**; 0.40 - Italy: .02 (.08); .30 (.10)**; 0.32 - Spain: .18 (.07)**; .02 (.08); 0.21 - Japan: .18 (.09)*; -.05 (.09); 0.13 - Korea: .18 (.08)*; -.03 (.09); 0.15 - Canada: .15 (.04)**; -.02 (.04); 0.13 - China: .52 (.27); -.49 (.27); 0.04 - Russia: -.16 (.17); .16 (.18); -0.01 - Baseline R2 = .06; DW = 1.46 - Table 2.2 / 2.3 summaries (Foreign Bond Yield and Dollar Exchange Rate regressions): - Advanced countries and Emerging Markets regressions report many coefficients; selected examples: - US 10 Year Yield coefficients across regions reported (examples): .16 (.02)**; .66 (.02)**; .39 (.02)**; .01 (.02); .69 (.07)**; .53 (.05)**. - Change Post-Crisis coefficients include values such as -.01 (.02); -.14 (.02)**; .03 (.03); - .68 (.10)**; -.80 (.12)**. - Note: A positive value indicates an appreciation against dollar in the dollar exchange rate regressions. - R2 and DW reported across regressions (examples): R2 = .08, DW = 1.27; another set R2 = .04, DW = 2.02. ### III. U.S. Financial Spillovers: Emerging Market Bond Spreads - Method: Fixed-effect panel regressions (2000q1–2010q2) of JP Morgan EMBI stripped spreads on: - Foreign rates: U.S. Treasury yields (constant maturity), LIBOR, the Fed funds rate, Fed funds futures (1 month and 3 month). - Market risk: VIX or High Yield Spreads (difference between yields to maturity of AAA and Baa corporate bonds). - Credit risk: S&P long-term credit outlook ratings (linear and quadratic scales; binary dummy for junk vs non-junk). - Domestic determinants: GDP growth, inflation, money multipliers, credit to GDP, trade balances, reserves, public deficits where available. - Key findings: - Push factors (U.S. interest rates and global risk measures) explain over half of the variation in spreads. - EM spreads move one-for-one with the U.S. high yield spread (proxy for risk). - Depending on specification, a 100 basis point decrease in yields on 10-year Treasuries would be associated with a 60–115 basis point reduction in EM spreads. - Relationship with U.S. short rates is less clear; coefficients on U.S. short-term interest rates are unstable and often negative. - Preferred interpretation: U.S. monetary policy affects long-term U.S. Treasury yields, which are then associated with changes in EM spreads. - Macroeconomic indicators: only growth and inflation are consistently significant; ratings are consistently significant. - Table 3.1 (Panel Regression Results for EM Spreads, after testing down) — selected coefficients (standard errors in parenthesis): - Constant: -2.483 (0.298); -2.56 (0.20); -0.036 (0.018); -0.039 (0.023) - 10-year Treasury yields *: 1.152 (0.235); 0.850 (0.128); 0.290 (0.115); 0.277 (0.114) - 3-month Treasury yields *: -0.115 (0.057); -0.096 (0.033); -0.086 (0.031) - High-yield spread *: 1.005 (0.066); 1.021 (0.043); 0.935 (0.049); 0.934 (0.049) - Real GDP growth, quarterly: 0.006 (0.004) - Inflation rate, quarterly: 0.048 (0.012) - Official reserves to GDP ratio, difference: 0.007 (0.003); 0.007 (0.003) - M2 to GDP ratio, difference: -0.003 (0.002) - Gross trade to GDP ratio, difference: 0.003 (0.002); 0.003 (0.002) - S&P long-term credit rating, quadratic scale *: 0.004 (0.001); 0.226 (0.126) - R2 examples: 0.810; 0.868; 0.505; 0.526 - Notes: Columns 1 and 2 use logs; Columns 3 and 4 use log differences. ### IV–VI. Growth and Trade Spillovers: Typical Responses and Supply Chain Effects - Model: Refined structural G-20 macroeconometric model (Vitek (2010)) used to analyze business cycle spillovers. - Findings on geographic patterns: - Peak impulse responses of output to U.S. real and financial shocks increase with geographical proximity. - Highest dependence: Canada and Mexico (strong trade and financial linkages), followed by Saudi Arabia (exchange rate and commodity price linkages). - Spillovers from U.S. real and financial shocks to other systemic economies are somewhat stronger than the reverse. - Asset price links: - Adding correlated term and equity risk premium shocks amplifies spillovers substantially and reduces international variability. - Assumed correlation coefficients across bond markets with respect to the United States: range from 0.16 to 0.66 for other advanced economies; 0.00 to 0.69 for emerging economies. - Across stock markets: assumed correlation coefficients 0.48 to 0.76 for other advanced economies; 0.00 to 0.87 for emerging economies. - U.S. role in global trade and supply chains: - United States accounts for about 11 percent of global trade (exports plus imports). - Exports to NAFTA members (Canada and Mexico) account for about 37 percent of total U.S. exports at their peak before the crisis. - The United States is the largest trading partner for Canada and Mexico, accounting for about two-thirds of overall trade in each country in 2010. - Foreign content in U.S. gross exports increased from 9.5 percent in 1995 to 12.3 percent in 2005. - U.S. is an upstream hub in the NAFTA supply chain: Mexico is downstream with specialized duty-free assembly plants that re-export final goods to the United States. - China’s contribution to U.S. manufacturing exports' foreign value added (FVA) rose to more than 11 percent in 2005; China’s share in high technology sector FVA rose from 7 percent in 1995 to about 24 percent in 2005. - Illustrative quantitative example (three-country world): - With given BXW, w, and τ vectors, a 1 percent increase in U.S. imports produces first-round impacts of 0.20 percent of EA’s GDP and ~0.27 percent of CN’s GDP in the example. - Heat-map result: Total impact of a U.S. import shock on partners’ non-commodity net exports (as percent of GDP) is highest for NAFTA partners (Canada and Mexico) and for South-East Asia, notably China. ### VII. U.S. Financial Spillovers: Crossborder Linkages - Key surveyed features of globally systemic financial sectors: - Asset size: Euro area financial system is largest; U.S. financial system is the most complex/diverse with large investment banking and money fund segments. - Overall foreign bank claims on the United States (March 2010): - Dollar Claims of U.S. Offices of BIS Reporting Banks on U.S. Residents, by nationality of foreign-owned large BHCs and primary dealers — Total = $2.914 trn. Selected nationalities: UK $830; Switzerland $349; Germany $349; Canada $269; Japan $158; France $75; Ireland $68; Spain $65; Netherlands $40; Other $609. - Consolidated U.S. Claims of BIS Reporting Banks on Ultimate Risk Basis, by nationality — Total = $5.175 trn. Selected: UK $1,143; Japan $960; Switzerland $661; France $573; Germany $516; Canada $444; Netherlands $274; Spain $192; Ireland $93; Other $318. - U.S. large BHC subsidiaries of foreign banks: - In almost all cases (except BNP Paribas and Bank of Nova Scotia) U.S. large BHC subsidiaries are more focused on investment banking (proxied by ratio of noninterest income to total income) than the rest of the group. - U.S. BHC assets vary from over one-third of group assets (Allied Irish) to under 3 percent (BNP Paribas); weighted average share of 11 percent. - Business models of foreign banks with U.S. BHC subsidiaries mapped by noninterest income % of total income and assets. ### VIII. U.S. Monetary Policy Spillovers: QE and Capital Flows into Emerging Markets - Method: VAR on weekly data from 2003 to study impact of Fed purchases (Treasury, Agency, mortgage backed securities), QE1 and QE2 announcement dummies, flows into EM bond and equity mutual funds, oil and nonoil commodity prices, and VIX. - VAR baseline ordering: Fed net asset purchases; QE1 and QE2 announcement dummies; net flows into EM funds. Lag length chosen: 6 weeks. - Main findings: - Fed announcements of QE seem to have a positive impact in driving net flows to EM, while actual Fed asset purchases did not. - QE1 and QE2 announcements are significant on impact. Long-term: QE1 announcement effects become smaller and insignificant; cumulative capital flows in response to QE2 announcements grow over time and remain marginally significant. - Adding global market conditions (changes in VIX and oil prices) shows: - Declines in the VIX and increases in oil prices both significantly contribute to flows to EMs. - Oil (and nonoil commodity) price increases drive larger flows into equity funds, with little impact on bond flows. - Effects of Fed QE announcements and asset purchases on oil prices and global risk aversion have expected signs but are not statistically significant in most cases. - Fed purchases have a (marginally) significant positive impact on oil price when MBS purchases are included (QE1 feature). - Immediate impact of QE1 announcements on the VIX is significant; other responses generally not significant. - Figures reported: Accumulated responses of EM inflows to Fed net purchases, QE1 announcements, QE2 announcements; accumulated responses of VIX and Oil Prices to QE actions. (Units in US$ mil. or index as labeled in figures.) ### IX. U.S. Growth Spillovers: Monetary Policy Scenarios - Scenario analyzed: Conventional and unconventional (QE1 and QE2) U.S. monetary stimulus using refined G-20 macroeconometric model. - Conventional U.S. monetary stimulus (unanticipated reduction in nominal policy interest rate) scenario calibration based on event study: - Scenario features an unexpected percentage point decrease in U.S. policy rates which reduces long-term nominal yields by 65 basis points in the United States. - Associated reductions in long-term nominal yields of: 10 to 54 basis points in other advanced economies, and 0 to 45 basis points in emerging economies. - Conclusion: Spillovers are large and mainly conveyed through asset price links; negative equity risk premium shocks raise equity prices (further amplification of spillovers). *Source: IMF staff analysis (extracted sections III–IX and selected tables and figures from the provided content).* ### 3.9 percent in the U.S., by 1.9 to 3.0 percent in other advanced economies, and by zero to ### _cr11203 - 3.9 percent in the U.S., by 1.9 to 3.0 percent in other advanced economies, and by zero to ### Typical monetary stimulus: calibrated impacts and transmission - Term premium shocks reduce long-term nominal interest rates by: - 3.9 percent in the U.S. - 1.9 to 3.0 percent in other advanced economies - zero to 3.4 percent in emerging economies - Equity risk premium shocks raise equity prices by: - 11.7 percent in the U.S. - 5.6 to 8.9 percent in other advanced economies - zero to 10.2 percent in emerging economies - Exchange rate risk premium shocks appreciate currencies (vs. dollar) by: - 0.9 to 1.2 percent in other advanced economies - zero to 1.1 percent in emerging economies - Estimated peak output gains (transmission primarily via bond markets): - 0.3 percent in the U.S. - 0.1 to 0.3 percent in other advanced economies - around zero to 0.2 percent in emerging economies ### QE1 scenario: larger financial and output effects - Negative term premium shocks reduce long-term nominal interest rates by: - 65 basis points in the U.S. - 10 to 27 basis points in other advanced economies - 0 to 100 basis points in emerging economies - Equity price increases: - 11.7 percent in the U.S. - 5.6 to 8.9 percent in other advanced economies - zero to 10.2 percent in emerging economies - Exchange rate appreciations (vs. dollar): - zero to 5.5 percent in other advanced economies - zero to 5.4 percent in emerging economies - Estimated peak output gains (transmission primarily via bond and stock markets): - 0.4 percent in the U.S. - 0.1 to 0.3 percent in other advanced economies - around zero to 0.4 percent in emerging economies ### QE2 scenario: modest effects - Negative term premium shocks reduce long-term nominal interest rates by: - 20 basis points in the U.S. - 3 to 8 basis points in other advanced economies - zero to 14 basis points in emerging economies - Equity price increases: - 0.8 percent in the U.S. - 0.4 to 0.6 percent in other advanced economies - zero to 0.7 percent in emerging economies - Exchange rate appreciations (vs. dollar): - zero to 0.9 percent in other advanced economies - zero to 1.0 percent in emerging economies - Estimated peak output gains (transmission primarily via bond markets): - 0.1 percent in the U.S. - close to zero percent in other advanced economies - close to zero to 0.1 percent in emerging economies ### Spillovers from delayed withdrawal of U.S. monetary stimulus - Strategy: credible extension of zero interest rate policy per Eggertsson and Woodford (2003) to reduce future short-term real rates and lower current long-term real rates. - Estimated peak output gains from delayed withdrawal in the United States: - 0.12 to 1.15 percent, depending on duration of the delay - Estimated weighted average peak output gains in other regions: - Other advanced economies: 0.01 to 0.09 percent - Emerging economies: 0.01 to 0.10 percent - Note: these simulations use sequences of negative U.S. monetary policy shocks and thus imply smaller spillovers than scenarios calibrated to internationally correlated risk premium shocks. ### U.S. fiscal spillovers to global financing conditions - Empirical basis: annual panel regressions using local-currency sovereign bond yields from 41 countries, 1990–2010. - Direct estimated effect of a one percentage point increase in the U.S. federal debt ratio (excluding Fed holdings) on sovereign spreads: - about 2 basis points (stronger effect in emerging markets) - Additional pass-through via long-term Treasury yields (Laubach (2009) elasticity): - prospective one percentage point increase in federal debt → about 3 basis points rise in long-term Treasury yields - Combined/direct-plus-pass-through could imply overall increase in local borrowing costs of some 5 basis points per additional percentage point of U.S. federal debt (interpreted with caution). - Contextual projection: - U.S. public federal debt projected increase from 36 percent of GDP before the crisis to 70 percent of GDP this year (statement preserved as in source). ### Regression highlights (Table 10.1) - Key coefficients (Full sample unless noted) and signs/statistical significance: - Federal Debt minus Fed Holdings of Treasuries (% of US GDP): 0.023*** - Federal Debt minus Fed Holdings of Treasuries (% of World GDP): 0.126*** - U.S. interest rates (long-term bond): 0.298*** - Domestic public debt (% of GDP): 0.012** (or 0.012*** in alternate specification) - Growth: -0.126*** - Inflation differential: 0.167*** - FX reserves (% GDP): -0.036*** - Current account (% GDP): -0.022 (not always significant) - Political institutions (ICRG): -0.080*** - VIX: 0.069** - Interaction effects (Table 10.2) indicate differential sensitivities: - U.S. Federal debt * Domestic public debt: red (statistically significant interaction) - U.S. Federal debt * Domestic growth: mixed signs across samples - U.S. Federal debt * FX reserves: negative interaction in full sample - U.S. Federal debt * Political institutions: negative interaction in full sample - Sample and specification notes: - Observations: 539 (full sample) - R-squared: 0.415 (full sample) - Sample: 41 countries, annual data, 1990-2010 - Robust t-statistics displayed in brackets; significance indicated as *** p<0.01, ** p<0.05, * p<0.1 ### Policy-relevant findings on mitigating spillovers - Strong domestic policies and institutions can reduce borrowing costs and dampen negative spillovers from rising U.S. public debt: - Reducing the local public debt ratio by 10 percent of GDP lowers the borrowing spread by 10–100 basis points depending on context. - Improving institutional quality (ICRG Composite Index) by 1 standard deviation could reduce the borrowing spread by 60–100 basis points. - Implication: early agreement on a comprehensive U.S. medium-term fiscal consolidation plan is reinforced by the analysis given potential domestic and global effects of rising U.S. debt. ### U.S. growth spillovers from fiscal policy: GIMF model results (summary) - Short-run effects of U.S. fiscal tightening: - Short-run output spillovers to other countries are uniformly negative but relatively small; GDP in other regions falls by a fraction of the U.S. GDP fall and recovers more quickly. - Reasons: focus on trade linkages in the scenario (direct trade impact small outside Canada and Mexico), and rapid domestic demand response in other regions to higher anticipated income from lower interest rates. - Long-run effects of permanent fiscal consolidation: - Real interest rates fall and output rises globally; world interest rates fall because U.S. is large in capital markets. - Composition and trade effects: - U.S. output shifts away from domestic toward external demand; other countries see the converse. - Trade balances deteriorate in other countries to accommodate U.S. fiscal consolidation. - Scenario variations and determinants: - Anticipated and credible fiscal policies reduce short-run spillovers. - Efficiency of deficit reduction matters: lower labor or capital income taxes more effective for long-run supply than reducing transfers or public consumption. - Monetary accommodation in other countries reduces spillovers. - A front-loaded adjustment increases short-run costs and negative spillovers. - Changes in risk premia can materially affect outcomes; credible consolidation that reduces risk premia can mitigate negative demand effects, while non-credible consolidation can worsen them. ### G-20 model simulations (setup) - Two scenarios analyzed with the G-20 structural macroeconometric model: - Baseline scenario: abstracts from any decline in long-term nominal interest rates due to U.S. fiscal consolidation. - Alternative scenario: accounts for the possibility of long-term nominal interest rate declines worldwide to varying degrees. - Both scenarios abstract from monetary policy stabilization worldwide to isolate fiscal policy effects. - Preliminary statement: projected U.S. fiscal consolidation would generate substantial domestic output losses under the baseline scenario (simulation results continue beyond the provided excerpt). *Prepared by Francis Vitek (SPR); sections by Martin Sommer and Grace Bin Li (WHD); Alasdair Scott with inputs from Ben Hunt and Stephen Snudden (RES) and Martin Sommer (WHD).* ### 2.2 percent over the period 2011– ### 2.2 percent over the period 2011– ### Fiscal consolidation scenarios and international spillovers - Scenario calibration and baseline assumptions: - Projected cumulative fiscal consolidation: 2.5 percent of output (April 2011 WEO fiscal impulse). - Alternative scenario assumption: long term nominal interest rate in the U.S. declines by 39 basis points by 2014. - Estimated cumulative U.S. output loss under alternative scenario: 1.3 percent. - Laubach (2009) calibration: a one percent reduction in the ratio of government debt to output is associated with a 3 to 4 basis point decline in the long term nominal interest rate. - Baseline spillover estimates (cumulative output losses, 2011–2016): - Other advanced economies: range from 0.1 to 1.4 percent. - Emerging economies: range from 0.1 to 1.0 percent. - Alternative spillover assumptions and estimates: - Pass-through assumptions to other economies: 16 to 66 percent of U.S. long term nominal interest rate declines pass through to other advanced economies; 0 to 69 percent pass through to emerging economies. - Estimated cumulative output effects under alternative scenario: - Other advanced economies: range from a loss of 0.5 percent to a gain of 0.4 percent. - Emerging economies: range from a loss of 0.2 percent to a gain of 0.6 percent. - Cross-country pattern: - Under both scenarios, estimated cumulative output losses in the rest of the world generally increase with the degree of trade integration with the United States. ### Sovereign debt crisis scenarios (G-20 model simulation results) - Model: refined structural macroeconometric model of the G-20 (Vitek (2010)). - Scenario 1 — Contained U.S. sovereign debt crisis: - Shocks on impact: - Term premium shock raising U.S. long term nominal interest rate by 450 basis points. - Equity risk premium shock reducing U.S. equity prices by 60 percent. - Loss of confidence decreases domestic demand by 1 percent. - Fiscal consolidation reaction reduces domestic demand by a further 2 percent. - Weighted average peak output losses: - United States: 4.4 percent. - Other advanced economies: 0.5 percent. - Emerging economies: 0.7 percent. - Scenario 2 — Contagious sovereign debt crisis (global bond and stock market spread): - Augmenting Scenario 1 with international shocks: - Term premium shocks raise long term nominal interest rates by 180 basis points in all other advanced economies and by 270 basis points in all emerging economies. - Equity risk premium shocks reduce equity prices by 30 percent in all other advanced economies and by 45 percent in all emerging economies. - Loss of confidence decreases domestic demand in all other economies by 1 percent. - Fiscal consolidation reactions reduce domestic demand by a further 1 percent in other advanced economies. - Weighted average peak output losses: - United States: 4.9 percent. - Other advanced economies: 3.6 percent. - Emerging economies: 3.5 percent. - Scenario 3 — Global bond and stock market collapses plus a run on the dollar (dollar depreciation): - Adds an exchange rate risk premium shock that depreciates the dollar by 30 percent in nominal effective terms on impact. - Resulting effect: implied real effective appreciation pressure on other currencies is disinflationary, raising scope for monetary policy loosening. - Weighted average peak output losses: - United States: 4.6 percent. - Other advanced economies: 3.5 percent. - Emerging economies: 3.2 percent. - Scenario 4 — Global bond and stock market stress with flight to quality (dollar appreciation): - Adds an exchange rate risk premium shock that appreciates the dollar by 15 percent in nominal effective terms on impact. - Resulting effect: implied real effective depreciation pressure on other currencies is inflationary, reducing scope for monetary policy loosening. - Weighted average peak output losses: - United States: 5.1 percent. - Other advanced economies: 3.7 percent. - Emerging economies: 3.7 percent. ### U.S. capital adequacy requirements: macroeconomic spillovers - Policy shock analyzed: - Binding one percentage point increase in U.S. capital adequacy requirements. - Analysis focuses on transitional costs transmitted via a permanent increase in the spread between commercial bank lending and deposit rates. - Baseline calibration uses a 0.12 percent increase in the interest rate spread, following MAG (2010). - Baseline scenario peak output loss estimates: - United States: peak output loss of 0.26 to 0.28 percent (depending on speed of implementation). - Other advanced economies: peak output losses range from 0.05 to 0.19 percent. - Emerging economies: peak output losses range from 0.05 to 0.16 percent. - Alternative scenario (abstracting from cross-border bank lending channel): - Other advanced economies: estimated peak output losses range from 0.03 to 0.16 percent. - Emerging economies: estimated peak output losses range from 0.03 to 0.12 percent. - These reduced spillovers reflect the importance of the cross-border bank lending channel and the high dependence of other advanced and emerging economies on credit provided by commercial banks incorporated in the United States. ### U.S. banking system risks: systemic versus individual solvency risk - Risk measures and methodology: - Systemic risk defined as the joint default risk among sample banks in each jurisdiction based on the multivariate distribution (MGEV) of joint CDS spread movements with a non-parametric dependence function; marginal distributions of individual CDS spread movements assumed to be generalized extreme value (GEV). - Individual risk defined as the average default risk weighted by the total assets of sample banks in each jurisdiction. - Two CDS measures used: - Actual one-year CDS spreads (proprietary data: Bloomberg and MarkIt). - Fair value (“synthetic”) one-year CDS spreads extracted from equity prices via contingent claims analysis (CCA). - Observation: synthetic CDS spreads are generally higher than actual CDS spreads due to implicit or explicit government guarantees reducing residual solvency risk reflected in actual spreads. - Key finding: - Both systemic and individual risk culminated in the first quarter of 2009. - This peak was followed by a persistent decline in individual risk until end-2009. *Prepared from the IMF content unit: _cr11203 - 2.2 percent over the period 2011–* ### 38. Jobst, A. A. and H. Kamil, 2008, “Stock Market Linkages Between Latin America and the United States ### 38. Jobst, A. A. and H. Kamil, 2008, “Stock Market Linkages Between Latin America and the United States During ‘Tail Events’” ### Relationship between individual and systemic banking-sector risk - Analysis shows eventual stabilization of system-wide risk at an elevated level in the wake of U.S. policy announcements (Figures 13.1–13.4). - Systemic risk subsequently declined in anticipation of U.S. policy measures in early 2010, such as the announcement of the “Volcker Rule” and the proposed imposition of a financial crisis responsibility tax, consolidating a trend towards lower systemic risk in the U.S. banking sector. - Interaction between individual and systemic risk was similar in both the United States and Europe, except for a slower decline of systemic risk (if measured by synthetic CDS) in Europe during the first half of 2010. - The slope of the relationship between individual and systemic risk appears to have flattened over time. - Three periods of relative stability in the individual–systemic risk relationship are identified: - (i) from the Lehman collapse to June 2009; - (ii) from July 2009 through the announcement of the Volcker rule (January 2010); - (iii) after the announcement of the Volcker rule. - Figures 13.1–13.4 indicate the usually positive relationship between U.S. banks’ individual risk and systemic risk flattened after the announcement of the Volcker rule; a similar pattern appears for European banks, suggesting positive spillovers. ### Dynamic Dependence Structure (DDS) — model, methodology, and scope - The DDS model is used to assess tail dependence and quantify the dependence structure between U.S. and European banking-sector risks. - The DDS model is based on multivariate extreme value theory (EVT) and measures whether extreme cross-border linkages exist and how they change over time, acknowledging large shocks are transmitted differently than small shocks. - Dependence values are calculated iteratively as central estimates on daily observations within a sliding one-year rolling window that is updated monthly. - The non-linear, non-parametric Chi-statistic based dependence measure is calculated iteratively on daily observations over a 5-month rolling window and monthly updating for some charts; for an event-study adaptation a sliding window of three months with daily updating is used. - Joint fair value one-year credit default swap (CDS) spreads are extracted from equity prices via an advanced version of CCA and aggregated via a multivariate generalized extreme value distribution (MGEV) to derive measures of systemic risk. - The sample period for Figures 13.1–13.4 is 06/26/07-09/10/10 (1,135 obs.) of daily observations (fair value or actual one-year CDS spreads depending on the figure). - The dependence value between banks in Europe and the United States is derived after calculating the joint default risk among all sample banks within each jurisdiction, estimating the multivariate distribution (MGEV) of joint CDS spread movements separately for each jurisdiction, and then determining bilateral linkages. ### Empirical findings on cross-border spillovers and tail dependence - Cross-border linkages of banking-sector risk increased dramatically during the credit crisis, especially for very large increases of default risk until mid-2009. - After a noticeable decline during the first half of 2010 amid lower systemic risk in the U.S. banking sector, spillover effects reemerged in the wake of persistent turmoil in the European periphery. - Until the end of 2009, the potential for spillovers was also more pronounced for declines in market-perceived solvency risk (i.e., lower CDS spreads), but such declines were much smaller than increases during 2009. - Spillover risks waned over the first half of 2010, stabilized briefly during mid-2010 amid lower systemic risk, then reemerged: during the last months of 2010 cross-border linkages to European peers exhibited growing susceptibility to common shocks and almost reached credit crisis levels in January 2011. - Three-dimensional charts (Figure 13.5) depict dependence between joint changes in fair value one-year CDS spreads since the onset of the credit crisis and during the European sovereign crisis, illustrating dependence across sizes of joint changes (e.g., Large Increase, Large Decline) and degrees of dependence (Dependence Measure in percent). - Time series of dependence values (Figure 13.6) track dependence between joint "synthetic" CDS spreads for large negative shocks (Top Quartile, 75th percentile and higher) from Sep-07 through Jan-11, showing dependence value movements across the sample period. ### Event-study adaptation and policy-announcement effects - The DDS model was adapted to an event-study framework using a sliding window of three months and daily updating to examine changes in the dependence measure in response to significant U.S. policy announcements. - The framework assessed spillover effects of U.S. policy announcements during the credit crisis on banking-sector risks in both the United States and Europe. - Findings show that U.S. policy announcements (e.g., the Volcker Rule) were associated with an eventual flattening of the relationship between individual and systemic risk and contributed to lower systemic risk in the U.S. banking sector; similar patterns in Europe suggest positive cross-border spillovers. *Content based on "38. Jobst, A. A. and H. Kamil, 2008, 'Stock Market Linkages Between Latin America and the United States During 'Tail Events''," as reproduced in the supplied PDF content.* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2011/_cr11203.pdf_