U.S. Monetary Policy Normalization and Global Interest Rates

IMF Working Papers, September 29, 2016

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The paper studies the impact of U.S. interest rates on rates in other countries as the Federal Reserve normalizes monetary policy.
There is a modest but nontrivial pass-through from U.S. to domestic short-term interest rates on average.
Much of the short-term comovement reflects synchronized business cycles.
There is important heterogeneity across countries, with evidence of limited monetary autonomy in some cases.
The co-movement of longer term interest rates is larger and more pervasive than for short-term rates.
Most countries receive greater spillovers from U.S. interest rate movements that surprise markets versus those that are anticipated.
Countries respond differently to shocks in the U.S. term premium versus shocks to the expected path of risk-free rates.
Determinants of monetary autonomy with strong evidence include: exchange rate flexibility and capital account openness; other relevant factors include dollarization of financial system liabilities and the credibility of fiscal and monetary policy.

Finding: Modest but nontrivial pass-through from U.S. to domestic short-term interest rates on average.
Mechanism: Much of the comovement is explained by synchronized business cycles.
Heterogeneity: Some countries exhibit limited monetary autonomy, indicating cross-country variation in pass-through.

Finding: Co-movement of longer term interest rates with U.S. rates is larger and more pervasive than for short-term rates.
Implication: Global yield curves show stronger alignment with U.S. longer-term rate movements.

Finding: Distinguishing between surprises and anticipated U.S. interest rate movements reveals that most countries experience greater spillovers from surprises (unanticipated rate hikes) than from anticipated moves.

Finding: Movements in the U.S. term premium and movements in the expected path of risk-free rates have different effects across countries.
Conclusion: Countries respond differently to term-premium shocks compared with shocks to the expected path of risk-free rates.

Strong evidence for the role of:
- Exchange rate flexibility
- Capital account openness
Additional important factors:
- Dollarization of financial system liabilities
- Credibility of fiscal and monetary policy

U.S. Monetary Policy Normalization and Global Interest Rates
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