DP15740 The Puzzling Change in the International Transmission of U.S. Macroeconomic Policy Shocks

Author(s): Ethan Ilzetzki, Keyu Jin
Publication Date: January 2021
Date Revised: April 2021
Keyword(s): Exchange Rates, International Financial Intermediation, International spillovers, monetary
JEL(s):
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=15740

We demonstrate a dramatic change over time in the international transmission of US monetary policy shocks. International spillovers from US interest rate policy have had a different nature since the 1990s than they did in post-Bretton Woods period. Our analysis is based on the a panel of 21 high income and emerging market economies. Prior to the 1990s, the US dollar appreciated, and ex-US industrial production declined, in response to increases in the US Federal Funds Rate, as predicted by textbook open economy models. The past decades have seen a shift, whereby increases in US interest rates depreciate the US dollar but stimulate the rest of the world economy. Results are robust to several identification methods. We sketch a simple theory of exchange rate determination in face of interest-elastic risk aversion that rationalizes these findings.