Monetary Policy Spillovers from the United States to the Euro Area

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Title: Monetary Policy Spillovers from the United States to the Euro Area
Author: Sintonen, Meri
Contributor: University of Helsinki, Faculty of Social Sciences, Department of Political and Economic Studies
Thesis level: master's thesis
Abstract: The global financial crisis 2008-2009 has shown the significance of the financial markets in the transmission of monetary policy on the real economy. Most of the literature examines the domestic effects of monetary policy, but the international transmission of monetary policy has received less attention. However, the monetary policy of the United States has shown to create booms and busts globally leading to recessions in other countries. In recent years, the empirical research on this area has rapidly grown, and the credit channel is proved to be an important mechanism the international transmission of monetary policy. This thesis contributes to the existing literature by studying the spillover effects of the US monetary policy on the euro area via credit channel. To analyze the causal effects of the US monetary policy on the euro area economy, I estimate the joint response of a variety of economic and financial variables to a US monetary policy shock. These responses can be evaluated within a structural vector autoregression (SVAR), which is identified using external instruments (also known as a proxy SVAR). Empirical studies have shown that basic identification methods of a structural VAR often fail to embody the contemporaneous reactions between fast-moving financial market variables and monetary policy. Therefore, I use a recently developed identification procedure, which uses high-frequency changes in the federal funds futures rates to identify the monetary policy shocks. These changes in the futures prices are calculated within narrow time windows around monetary policy announcements by the Federal Reserve so that they can be considered to be almost pure measures of unexpected policy actions by the Fed. The surprises based on the futures contracts also yield another advantage, since they include also shocks to forward guidance. This important during a period the central bank hit the zero lower bound. This thesis provides empirical evidence on that the US monetary policy shocks are transmitted to the euro area via the credit channel. I find that credit costs, measured by mortgage spread and corporate bond spread, are significantly affected by US monetary policy shocks. In addition, I find that stock prices significantly decrease in the euro area as a response to Fed's tightening. The magnitude of the responses is virtually the same as within US borders. Moreover, I find that Fed's tightening leads to depreciation of the euro against the dollar, which is accompanied by a decline in output level and inflation. However, the significance of the output level's response depends on the model specification, but otherwise, my results are robust to alternative model specifications. Furthermore, the results obtained in this thesis are consistent with other researchers' findings. Therefore, my results suggest that the US monetary policy shocks transmitted to the euro area through the credit channel, thus leading to an increase in credit costs and slowdown in economic activity. I conclude that additional macroprudential tools are needed to insulate economies from the spillover effects originating from the US monetary policy.
URI: URN:NBN:fi:hulib-201807022919
Date: 2018
Discipline: Taloustiede

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