Monetary Policy Shocks from the EU and US: Implications for Sub-Saharan Africa

Kronick, Jeremy (2014): Monetary Policy Shocks from the EU and US: Implications for Sub-Saharan Africa.

Abstract

This paper addresses the debate in the literature on how developing countries are affected by foreign monetary policy shocks. I analyze how contractionary monetary policy shocks originating in different regions, specifically the Euro Area (“EU”) and United States (“US”), affect a set of rarely investigated sub-Saharan African (“SSA”) countries. Foreign monetary policy shocks are identified using changes in central bank futures rates, and are inserted into a domestic structural vector autoregression (“SVAR”). Results differ depending on which of the EU or US shocks monetary policy and whether or not the recipient SSA country has a floating or fixed exchange rate regime. Specifically, floating exchange rate countries have a mostly negative GDP response following either shock due to a reliance on capital flows and external debt, and the implications these have for domestic interest rate responses. Fixed exchange rate countries have mixed GDP responses following the EU shock, as both trade and the effect of capital control usage on interest rates play an important role, while US shocks produce positive GDP responses as aid from the US dominates both trade and interest rates. The implications of these results for floating exchange rate countries is that diversification of foreign external debt and a reduction in reliance on international capital may be beneficial. For fixed exchange rate countries the implication is that capital controls can be a positive tool in the development process.

• Item Type: MPRA Paper
• Language: English
• Keywords: Monetary policy, international transmission of shocks, economic growth, sub-Saharan Africa
• Subjects: E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance; O - Economic Development, Innovation, Technological Change, and Growth > O1 - Economic Development; O - Economic Development, Innovation, Technological Change, and Growth > O5 - Economywide Country Studies

References

Abad, P. and H. Chulia (2013). “European Government Bond Markets and Monetary Policy Surprises: Returns, Volatility and Integration.” Research Institute of Applied Economics, University of Barcelona, Working Paper 2013/25.

Abradu-Otoo, P., B. Amoah, and M. Bawumia (2003). “An Investigation of the Transmission Mechanisms of Monetary Policy in Ghana: A Structural Vector Error Correction Analysis.” Bank of Ghana Working Paper WP/BOG-2003/02.

Bai, J. and S. Ng (2013). “Principal Components Estimation and Identification of Static Factors.” Journal of Econometrics 176: 18-29.

Barakchian, S.M. and C. Crowe (2013). “Monetary policy matters: Evidence from new shocks data.” Journal of Monetary Economics, http://dx.doi.org/10.1016/j.jmoneco.2013.09.006

Bernanke, B.S. (1986). “Alternative explorations of the money-income correlation.” Carnegie Rochester Conference on Public Policy 25: 49-99.

Bernanke, B.S. and A. Blinder (1992). “The federal funds rate and the channels of monetary transmission.” American Economic Review 82, 901-921.

Bernanke, B.S., J. Boivin, and P. Eliasz (2005). “Measuring the Effects of Monetary Policy: A Factor-Augmented Vector Autoregression (FAVAR) Approach.” The Quarterly Journal of Economics, Vol. 120, No. 1 (Feb. 2005), pp. 387-422.

Blanchard, O.J., Watson, M.W. (1986). “Are business cycles all alike?” Gordon, R. (Ed.) The American business cycle: Continuity and Change. University of Chicago Press, Chicago, pp.123-156.

Bredin, D., S. Hyde, D. and G. O'Reilly (2009). “European Monetary Policy Surprises: The aggregate and sectoral stock market response.” International Journal of Finance and Economics, 14(2), pp.156-171.

Buigut, S. (2009). “Monetary Policy Transmission Mechanism: Implications for the Proposed East African Community (EAC) Monetary Union.” mimeo. Available at: www.csae.ox.ac.uk/conferences/2009-EDiA/papers/300-Buigut.pdf

Canova, F. (2005). “The Transmission of US Shocks to Latin America.” Journal of Applied Econometrics 20: 229-251.

Cheng, K.C. (2006). “A VAR Analysis of Kenya's Monetary Policy Transmission Mechanism: How Does the Central Bank's REPO Rate Affect the Economy?” IMF Working Paper 06/300.

Christiano, L., M. Eichenbaum, and C. Evans (1996). “The effects of monetary policy shocks: evidence from the flow of funds.” Review of Economics and Statistics 78, 16-34.

Christiano, L., M. Eichenbaum, and C. Evans (1999). “Monetary policy shocks: what have we learned and to what end?” in: J.B. Taylor and M. Woodford, eds., Handbook of macroeconomics, (Elsevier, New York).

Cushman, D.O., and T. Zha (1997). “Identifying monetary policy in a small open economy under flexible exchange rates.” Journal of Monetary Economics 39: 433-448.

Darvas, Zsolt (2012a). “Real effective exchange rate for 178 countries: A new database.” Working Paper 2012/06, Bruegel, 15 March 2012.

Darvas, Z. (2012b). “Compositional effects on productivity, labour cost, and export adjustment.” Policy Contribution 2012/11, Bruegel, 22 June 2012.

Ehrmann, M. and M. Fratzscher (2009). “Global Financial Transmission of Monetary Policy Shocks.” Oxford Bulletin of Economics and Statistics, 71, 6: 739-759.

Evans, M.D.D. and V. Hnatkovska (2005). “International Capital Flows Returns and World Financial Integration.” NBER Working Paper 11701.

Faini, R. (2006). “Foreign aid and fiscal policy.” CEPR Discussion Paper No. 5721.

Farmer, R. (1997). “Money in a real business cycle model.” Journal of Money, Banking and Credit 29: 568-611.

Faust, J., E. Swanson, and J. Wright (2004). “Identifying VARs based on high-frequency futures data.” Journal of Monetary Economics 6: 1107-1131.

Gallagher, K. (2011). “The IMF, Capital Controls and Developing Countries.” Economic & Political Weekly Vol XLVI No 19.

Geiger, M. (2006). “Monetary policy in China (1994-2004): Targets, instruments and their effectiveness.” Wurtzburg Economic Paper No. 68.

Grilli, V. and N. Roubini (1995). “Liquidity and exchange rate puzzles: puzzling evidence from the G-7 countries.” Working Paper, Yale University, New Haven, CT.

Gordon, D.B. and E.M. Leeper (1994). “The dynamic impacts of monetary policy: an exercise in tentative identification. Journal of Political Economy 102: 228-247.

Hamilton, J.D. (1994). “Time Series Analysis.” Princeton: Princeton University Press.

Hoffmaister, A. and J. Roldos (1997). “Are business cycles different in Asia and Latin America.” IMF Working Paper, 97-9.

Ivanov, V. and L. Kilian (2001). “A Practitioner's Guide to Lag-Order Selection for Vector Autoregressions.” CEPR Discussion Papers 2685.

Jannsen, N. and M. Klein (2011). “The International Transmission of Euro Area Monetary Policy Shocks.” Kiel Institute for the World Economy Working Papers No. 1718.

Jones, C.I. (2009). “A Supplement to Macroeconomics.” Macroeconomics. W.W Norton & Company New York London.

Kim, S. (1999). “Do monetary policy shocks matter in G-7 countries? Using common identifying assumptions about monetary policy across countries.” Journal of International Economics 48: 387-412.

Kim, S. (2002). “Exchange rate stabilization in the ERM: identifying European monetary policy reactions.” Journal of International Money and Finance 21: 413-434.

Kim, S. (2001). “International transmission of U.S. monetary policy shocks: Evidence from VARs.” Journal of Monetary Economics 48: 339-372.

Kim, S. and N. Roubini (2000). “Exchange rate anomalies in the industrial countries: A solution with a structural VAR approach.” Journal of Monetary Economics 45: 561-586.

Kozluk, T. and A. Mehrotra (2009). “The Impact of Chinese Monetary Policy Shocks on East Asia.” Economics of Transition 17(1): 121-145

Kuttner, K.N. (2001). “Monetary policy surprises and interest rates: evidence from the federal funds futures market.” Journal of Monetary Economics 47: 523-544.

Leeper, E.M., C.A. Sims, and T. Zha (1996). “What does monetary policy do?” The Brookings Papers on Economic Activity 2, 1-48.

Lutkepohl, H. (1993). “Introduction to Multiple Time Series Analysis.” Second Edition. Berlin: Springer-Verlag, 1993, Chapter 4.

Lutkepohl, H. (2005). “New Introduction to Multiple Time Series Analysis.” New York: Springer.

Mackowiak, B. (2006). “What does the Bank of Japan do to East Asia?” Journal of International Economics 70: 253-270.

Mackowiak, B. (2007). “External shocks, U.S. monetary policy and macroeconomic fluctuations in emerging markets. Journal of Monetary Economics 54: 2512-2520.

Mishra, P. and P. Montiel (2012). “How Effective is Monetary Transmission in Low-Income Countries? A Survey of the Empirical Evidence.” IMF Working Paper WP/12/143.

Ncube, M., E. Ndou, and N. Gumata (2012). “How are the US Financial Shocks Transmitted into South Africa? Structural VAR Evidence?” African Development Bank Working Paper Series No. 157 - October 2012.

Ncube, M., E. Ndou, and N. Gumata (2012). “ The Impact of Euro Area Monetary and Bond Yield Shocks on the South African Economy: Structural Vector Autoregression Model Evidence. African Development Bank Working Paper Series No. 161 - December 2012.

Nilsson, R. (1987). “OECD Leading Indicators.” OECD Economic Studies No. 9, Paris.

Obstfeld, M. and K. Rogoff (1995). “Exchange rate dynamics redux.” Journal of Political Economy 103, 624-660.

Opoku-Afari, M. and S. Dixit (2012). “Tracking Short-Term Dynamics of Economic Activity in Low-Income Countries in the Absence of High-Frequency GDP Data.” IMF Working Paper WP/12/119.

Owyang, M., V. Ramey, and S. Zubairy (2013). “Are Government Spending Multipliers Greater During Periods of Slack? Evidence from 20th Century Historical Data.” Federal Reserve Bank of St. Louis Working Paper 2013-004A.

Pagan, A. and R. Fry (2011). “Sign Restrictions in Structural Vector Autoregressions: A Critical Review.” Journal of Economic Literature, Vol. 49, Issue 4, pp. 938-960.

Pallage, S. and M.A. Robe (2001). “Foreign aid and the business cycle.” Review of International Economics, Vol. 9, Issue 4, pp. 641-672.

Reside, R. (2004). “International Transmission of US Monetary Policy Shocks: VAR Evidence from the Philippines.” Discussion Paper No. 0405.

Romer, C.D., and D.H. Romer (2004). “A new measure of monetary shocks: derivation and implications.” American Economic Review 94: 1055-1084.

Saxegaard, M. (2006). “Excess Liquidity and Effectiveness of Monetary Policy: Evidence from Sub-Saharan African.” IMF Working Paper 06/115.

Sims, C.A. (1980). “Comparison of interwar and postwar business cycles: monetarism reconsidered. American Economic Review, Paper and Proceedings 70: 250-257.

Sims, C.A. (1986). “Are forecasting models usable for policy analysis? Quarterly Review of the Federal Reserve Bank of Minneapolis 10: 2-16.

Sims, C.A. (1992). “Interpreting the macroeconomic time series facts: the effects of monetary policy.” European Economic Review 36: 975-1000.

Sims, C.A., Zha, T., (1999). “Error bands for impulse responses.” Econometrica 67: 1113-1155.

Sims, C. and T. Zha (2006). “Does Monetary Policy Generate Recessions?” Macroeconomic Dynamics. 10(2): 231-272.

Soderstrom, U. (2001). “Predicting monetary policy with Federal funds futures prices.” Journal of Futures Markets 214: 377-391.

Svensson, L. and S. Van Wijnbergen (1989). “Excess capacity, monopolistic competition and international transmission of monetary disturbances.” Economic Journal 99, 785-805.

United Nations Conference on Trade and Development 2012. Development and Globalization: Facts and Figures.

Vajs, S. (2014). “Government debt issuance: issues for central banks.” BIS Papers No. 76.

Weber, A., R. Gerke, and A. Worms (2009). “Changes in the euro area monetary transmission?” Applied Financial Economics 21(3): 131-145.