Introduction

The changes in the United States (US) interest rates have a strong impact on economic conditions in other countries. With the increasing globalization of most countries in the world, the influence of the US monetary shocks has been a major concern in developed as well as developing countries. The international monetary transmission has a long history of debate. The Mundell-Fleming framework shows that a monetary expansion raises domestic production and income, but the monetary expansion induced boom at home is found to be at the expense of the foreign country, through the expenditure-switching mechanism under perfect capital mobility and a floating exchange rate regime. However, empirical evidence shows that the effects of US monetary policy has positive spill-over effects on Non-US Group of Seven countries' output and demand (Kim 2001). In this regard, modern sticky price models can theoretically reproduce the positive spill over effects of US monetary expansion on foreign output (Obstfeld and Rogoff 1995; Betts and Devereux 2001).

However, different transmission channels can be formed in response to external monetary shocks under different exchange rate regimes. A few past studies investigated this issue. Giovanni and Shambaugh (2008) concluded that only in the pegged countries is real gross domestic product (GDP) growth affected by external monetary shocks. Countries with a free floating regime show no relationship between real GDP growth and the base interest rates. They conclude that the main transmission channel is interest rates, in that pegged countries move their interest rates with the base country interest rates while floats do not. Frankel, Schmukler, and Serven (2004) also investigate the transmission of international interest rates to domestic rates depending on the exchange rate regime. They concluded that the full transmission of domestic interest rates occurred in the long run regardless of the exchange rate regime, but that short-run effects differed across different regimes. Moreover, they found that the interest rates of countries with more flexible exchange rate regimes adjust more slowly to changes in international rates, implying some capacity for monetary independence. On the other hand, Miniane and Rogers (2007) found no evidence that countries with more capital controls are less affected by foreign monetary shocks, implying that capital controls do not play a role in international transmission mechanism.

Since the Great Crash of 2008, the question of how a country can mitigate effects from external shocks has been increasingly raised among emerging market economies. East Asian countries have suffered from the shocks that originated with the sub-prime crisis in the US. One interesting area to investigate is how US monetary policy affects East Asia. This is relevant for the choice of exchange rate regime in the region. East Asian countries have various exchange rate regimes, from hard peg to free floating. The question is whether the choice of a different exchange rate regime can result in different spill-over effects from the US monetary shocks. If so, what should Asia take as its desirable exchange rate regime?

To address these questions, this paper examined the effects of US monetary policy shocks on monetary and foreign exchange policy variables and exchange rates. The paper addressed whether interest rates of East Asian countries is unaffected by US interest rate changes, showing monetary policy autonomy, whether US interest rate changes affect the exchange rates of East Asian countries against the dollar, and the foreign exchange reserves changes, reflecting strong foreign exchange intervention, among other issues.

This is an important question in relation to the transmission of US monetary policy shocks, since responses of monetary policy and exchange rates of East Asian countries have crucial implications on the transmission of the US monetary policy changes to East Asian countries. For example, appreciation of East Asian exchange rates following US monetary expansion can make East Asian countries suffer from a negative beggar-thy-neighbor effect. A decrease in East Asian interest rates following US monetary expansion, however, may generate a positive spillover effect to East Asian countries.

In addition, monetary independence has played a central role in the debate over the choice of exchange rate regimes. With capital now being mobile internationally, the policy choice under trilemma remains with either stable exchange rate or monetary independence. Proponents of floaters have argued that floater countries would able to pursue their own independent monetary goals, while advocates of hard peg have questioned the feasibility of such a strategy in a world of highly mobile international capital. On the other hand, even under fixed exchange rate regime, theoretically the monetary independence can be secured with the help of capital account restrictions.

To examine this issue, we employed the structural Block-Exogenous vector autoregression (VAR) model. The structural VAR model is useful to identify the US monetary policy shocks, which is the focus of this paper. On the other hand, the Block-Exogenous VAR model in which the US variables are exogenous to variables of East Asian countries is used since most East Asian countries can be regarded as small, open economies that have a minor effect the US or global economic conditions. The use of block-exogenous VAR modeling also helps to save the degree of freedom.

Download this Paper [ PDF 424.7KB| 25 pages ].

Comment(s)

There are [0] comment(s) for this entry. Post a comment.