Monday, May 17, 2021

New York Fed: "How Does U.S. Monetary Policy Affect Emerging Market Economies?"

In April 2016 we posted "Global Macro: There Are Many Ways To Approach It, Here's A Good One" with this introduction:

A couple weeks ago I emailed a friend:
Re: posts on money
Years ago one of the mentors said you can approach macro from a lot of starting points, for him it was bonds, he had internalized the price/interest rate teeter-totter to the point that if the other parts of the matrix, currencies or metals or equities, whatever, didn't fit the paradigm he'd know he was looking at either danger or opportunity.
I can't go so far as to say they are all fungible but along with empirically derived lead/lag times, grit in the gears/slippage inefficiencies and leverage it's a close enough first approximation to use as a mental model.

The key is to have enough exposure to your subject that your understanding is innate, that you don't have to consciously think "Now when interest rates go down, bonds go up". When you've achieved this level of mastery you immediately sense when the presented facts aren't conforming to the mental model and may be worth further scrutiny.

Another way in to global macro is commodities and if this is your choice it helps to internalize curves to the point the dangers/opportunities pop when you look at them.

Permit me to present Izabella Kaminska, writing at FT Alphaville:
Bringing balance to the commodity force, not leaving it in surplus

I thought of that post because today's posts are approaching global macro from a rates/FX point of view, rather than a commodities angle-of-attack. But  in the end it gets you to the same place.

The first rule of ecology: Everything is connected.*

And the headline article from the Federal Reserve Bank of New York's Liberty Street Economics blog, May 17:

The question of how U.S. monetary policy affects foreign economies has received renewed interest in recent years. The bulk of the empirical evidence points to sizable effects, especially on emerging market economies (EMEs). A key theme in the literature is that these spillovers operate largely through financial channels—that is, the effects of a U.S. policy tightening manifest themselves abroad via declines in international risky asset prices, tighter financial conditions, and capital outflows. This so-called Global Financial Cycle has been shown to affect EMEs more forcefully than advanced economies. It is because higher U.S. policy rates have a disproportionately larger impact on rates in EMEs. In our recent research, we develop a model with cross-border financial linkages that provides theoretical foundations for these empirical findings. In this Liberty Street Economics post, we use the model to illustrate the spillovers from a tightening of U.S. monetary policy on credit spreads and on the uncovered interest rate parity (UIP) premium in EMEs with dollar-denominated debt.

Real Effects of U.S. Monetary Policy on EMEs
We start by estimating the effects of U.S. monetary policy on EMEs, using a structural vector autoregressive model (SVAR) model including EME GDP and U.S. variables such as GDP, inflation, unemployment, capacity utilization, consumption, investment, and the federal funds rate for the period 1978:Q1-2008:Q4. The key identification assumption in the SVAR model is that the only variable that the U.S. monetary policy shock affects contemporaneously is the federal funds rate.

The results are shown the chart below. The red line in each panel indicates the point estimates of the impulse response functions, while the gray dotted lines mark the corresponding 95 percent probability bands. The blue line shows the predictions of our model, where we calibrate the larger economy to the United States, and take the smaller economy to represent a bloc of EMEs, such as the Asian or the Latin American EMEs. Starting with the U.S. economy, the model captures the dynamic response of U.S. output to a U.S. monetary policy shock remarkably well. A monetary policy innovation that raises the U.S. federal funds rate by 100 basis points induces U.S. output to fall around 0.50 percent at the trough, very close in magnitude to those implied by our model.

How Does U.S. Monetary Policy Affect Emerging Market Economies?


Earlier today:
"Treasuries Call the Tune in FX"
"Q2 GDP Forecasts: Around 10%"

*The "everything is connected" framework also made James Burke a pretty decent living. If interested see:

November 2013
When Storylines Intersect: China's Plenum Reforms Not Good For Australian Commodities
*The law made a small fortune for James Burke:
Connections explores an Alternative View of Change (the subtitle of the series) that rejects the conventional linear and teleological view of historical progress. Burke contends that one cannot consider the development of any particular piece of the modern world in isolation.

Rather, the entire gestalt of the modern world is the result of a web of interconnected events, each one consisting of a person or group acting for reasons of their own (e.g., profit, curiosity, religious) motivations with no concept of the final, modern result of what either their or their contemporaries' actions finally led to. The interplay of the results of these isolated events is what drives history and innovation, and is also the main focus of the series and its sequels.

To demonstrate this view, Burke begins each episode with a particular event or innovation in the past (usually Ancient or Medieval times) and traces the path from that event through a series of seemingly unrelated connections to a fundamental and essential aspect of the modern world. For example, The Long Chain episode traces the invention of plastics from the development of the fluyt, a type of Dutch cargo ship....MUCH MORE
November 2016:
"James Burke’s New Project Aims to Help us Deal with Change, Think Connectively, and Benefit from Surprise"