Back Matter

Back Matter

Carolina Osorio, and Esteban Vesperoni
Published Date:
September 2016
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    Appendix 1: Spillovers and Synchronicity in the United States and the Euro Area: Developments During Selected Monetary Policy Cycles

    The easing cycle in 2001–03 is an example of synchronous real and monetary conditions in the United States and the euro area:

    • After years of rapid expansion, economic activity in the United States peaked in 2000:Q2, with annualized year-over-year growth reaching 5¼ percent. By end-2000, growth had collapsed to less than 3 percent, and the economy continued to decelerate in 2001, reaching a cyclical low toward the end of the year. The recovery was rather bumpy until mid-2003 but consolidated by early 2004. Despite the sharp deceleration in the second half of 2000, the Federal Reserve kept the policy rate constant until December and began a gradual easing in January 2001. The slow monetary easing and a surprising sharp increase in the term premium—from less than 0.4 percent in January 2001 to about 1.7 percent by the summer of 2002 (see chart on the right)—likely prevented monetary conditions to ease as warranted by cyclical developments (Figure A1.2, panels 1, 3, and 5). The downward pressure from domestic real shocks to U.S. yields point to negative surprises on economic activity throughout 2001 (dark red of panel 3, Figure A1.2)—with somewhat volatile perceptions, likely associated with volatility in underlying data, as noted above. The framework also captures the slow reaction by the Federal Reserve and the increase in the term premium as a positive contribution of money shocks to yields. 1

    • The euro area economy had also experienced a rapid recovery starting in late 1998, with the economy peaking during the first quarter of 2001 (at an annualized year-over-year rate of 5½ percent). However, growth turned around in the second quarter and bottomed out in early 2002. Activity remained subdued until mid-2003, when a recovery began to take place. The ECB began a monetary easing cycle in early 2001, but it interrupted it in November of that year, keeping the policy interest rate constant for a year despite weak economic activity (Figure A1.2, panels 2, 4, and 6). The negative contribution of domestic real shocks to euro area yields reflect persistent negative surprises on the economic outlook throughout 2001, which became larger during 2002 and early 2003. Panel 6 points to increasing upward pressure on yields from money shocks in late 2001, likely reflecting the interruption of monetary policy easing by the ECB. The positive contribution of domestic money shocks stabilized in late 2002, however, as the ECB resumed its loosening of monetary policy. This period was characterized by large spillovers from the United States to the euro area: money spillovers were large (light blue bars of panel 6, Figure A1.2), and real spillovers were smaller but significant (light red bars in panel 4, Figure A1.2). Spillovers from the euro area to the United States were more modest: considerable in size for real shocks (Figure A1.2, light red bars in panel 3) and negligible for money shocks (Figure A1.2, light blue bars in panel 5).

    Figure A1.2.U.S and EA 10-Year Yield Decomposition in the 2001 Federal Reserve Easing

    (cumulative change)

    Sources: Bloomberg L.P.; and IMF staff estimates.

    Note: U.S.=United States; EA=euro area.

    Federal Funds Rate and Term Premium


    Source: Federal Reserve Board, and Kim and Wright (2005).

    The easing cycle in 2007–09 is an example of asynchronous real and monetary conditions in the United States and the euro area:

    • As the U.S. subprime crisis unraveled with larger-than-expected adverse effects on the real economy, domestic real shocks started to put downward pressure on U.S. 10-year yields (dark red bars in panel 3, Figure A1.3). The negative contribution of these shocks increased in the first quarter of 2008, as fears of a deeper-than-anticipated recession emerged, when the Federal Reserve provided an emergency loan to Bear Stearns to avert a sudden collapse of the company. In the second half of 2008, another wave of domestic real shocks in the United States started to drive yields down, this time reflecting negative growth surprises associated with the placement of Fannie Mae and Freddie Mac into conservatorship, the collapse of Lehman Brothers, and the bailout of AIG. Indeed, U.S. economic activity contracted sharply during this period, with average quarterly growth rates between 2007:Q3 and 2008:Q3 falling to virtually zero. The contribution of domestic U.S. money shocks was initially negative but very small, likely reflecting the fast and sharp easing of monetary policy stance at the onset of the crisis (dark blue bars in panel 5, Figure A1.3). However, toward the second half of 2008, domestic money surprises started to push U.S. 10-year yields up, possibly capturing the liquidity squeeze in financial markets around the collapse of Lehman Brothers, as well as market participants’ misperceptions (or incomplete information) about the strategies authorities would follow toward stressed financial institutions.

    • In 2007, growth held up relatively well in the euro area, as captured by the positive contribution of real domestic shocks to euro area yields (dark red bars in panel 4, Figure A1.3). However, output growth fell sharply in the second half of 2008, as the recession in the US generated negative growth spillovers to the euro area (light red bars in panel 4, Figure A1.3). Notwithstanding the deterioration in economic activity, the ECB kept its policy rate on hold through 2008:Q3. Market participants likely perceived the monetary policy stance as being “too tight” given the weak cyclical position, a phenomenon which our model captures as a positive contribution to yields from domestic money shock (dark blue bars in positive territory of panel 6, Figure A1.3.). Subsequently, as the euro area economy fell into recession following the collapse of Lehman Brothers, the ECB started an easing cycle, cutting its policy rate aggressively by more than 400 bps between September 2008 and May 2009. These actions helped reduce euro area 10-year yields (dark blue bars in negative territory of panel 6, Figure A1.3.).

    • Investor risk-aversion increased sharply with news about the vulnerabilities of large U.S. financial institutions (Bear Stearns, Lehman Brothers, etc.), pushing yields down (“risk-off”) in both the United States and euro area (yellow bars in panels 1 and 2, Figure A1.3).

    • This period was characterized by important real spillovers from the United States to the euro area, notably in the second half of 2008. In contrast, real spillovers from the euro area to the United States were small. As regards to money shocks, there were significant two-way spillovers between the two economies, which were mostly asynchronous. Therefore, external money shocks tended to dampen the effects of domestic ones on the economy’s own yields.

    Figure A1.3.United States and euro area 10-Year Yield Decomposition in the 2007 Federal Reserve Easing

    (cumulative change)

    Sources: Bloomberg L.P.; and IMF staff estimates.

    Note: U.S.=United States; EA=euro area.


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    In this note, monetary conditions refer to the evolution of long-term yields—as opposed to short-term rates—which reflect conventional and unconventional monetary policy developments, exogenous shocks to the term premium, and inflation surprises, including in response to oil price shocks. So, changes in monetary conditions can reflect the dynamics of any of these factors at different times.

    Focusing only in the United States and the euro area ensures tractability of the analysis, in particular to analyze synchronicity. What is more, the analysis could allow drawing broader lessons about synchronicity, as the recovery in the United Kingdom is similar to the one in the United States, and the one in Japan similar to the euro area.

    Other references for spillovers from the euro area to the United States are, for example, Ehrmann and Fratszcher (2005) and IMF (2015).

    In contrast, approaches that rely on the identification of money shocks on a country-by-country basis would not allow for the analysis of synchronicity and spillovers between systemic economies, as purely domestic shocks would not be well identified.

    Conversely, approaches that use narrow definitions of monetary policy—that is, based on the analysis of decisions on monetary policy rates—cannot address this challenge.

    In general, there is agreement that the VIX, although an index of volatility in U.S. markets, captures developments that prompt global investors to search for safe haven assets (see Bekaert, Hoerova, and Lo Duca 2013). Since investors can move to safe assets in both Europe and the U.S., movements in the VIX can, in principle, impact yields in both economies.

    For the United States, we use the S&P 500 stock price index, and for the euro area stock prices and bond yields correspond to the purchasing power parity–GDP-weighted average of these variables in France, Germany, Italy, and Spain.

    The recursiveness assumption makes more sense for models estimated at a daily frequency. We purged the data using both daily and monthly time series, but the results did not change much qualitatively or quantitatively.

    Bekaert, Hoerova, and Lo Duca (2013) suggest that there is a two-way interaction between real and monetary developments and the VIX, which raises endogeneity issues in trying to disentangle movements in the VIX associated with “pure” risk-appetite shocks. The proposed methodology strips out the risk-appetite component associated with identified shocks to the VIX. However, the data still contain information on autonomous shocks to stock prices and bond yields that can affect the VIX.

    Ehrmann, Fratzscher, and Rigobon (2011) impose similar restrictions to identify country-specific shocks. Given that the U.S. economy is bigger than the euro area, this sign restriction is assumed to be satisfied contemporaneously if shocks originate in the United States and with a lag if shocks originate in the euro area. If this restriction is imposed contemporaneously on shocks originated in both the United States and the euro area, the results presented in the next section remain broadly unchanged.

    The model identification issue is not specific to sign restricted VARs (Fry and Pagan 2010). For instance, if a recursive ordering is used to identify the model, many such orderings can have the same fit to the data.

    EPFR data track retail and institutional portfolio flows by country and asset type. The database covers some 11,000 equity funds and about 4,500 fixed-income funds, but the coverage for institutional investment flows is relatively small. Therefore, EPFR institutional portfolio flows may not be a good proxy for the entire universe of institutional investment flows.

    The contribution of domestic real shocks to changes in the U.S. yields is in line with consensus forecasts revisions of U.S. growth.

    The effects of real and money shocks on the U.S. dollar-euro exchange rate are assessed with a simple VAR framework. The model is estimated at a monthly frequency. The vector of endogenous variables includes the monthly changes in the contribution of domestic real and money shocks to the yields of the two economies, the bilateral U.S. dollar-euro exchange rate, and the contribution of risk-appetite shocks to monthly changes in U.S. 10-year yields (the latter has a correlation of 0.97 with the contribution of risk-appetite shocks to changes in euro area yields, reflecting the global nature of the variable). The results are robust to using contributions of risk-appetite shocks to U.S. or euro area yields, as well as the VIX in first differences. The model is identified with exclusion restrictions in the matrix of contemporaneous coefficients. We assume that changes in yields driven by real and money shocks in the United States and euro area are independent from each other (consistent with the fact that the underlying shocks are orthogonal). We also assume that structural exchange rate shocks do not have a contemporaneous impact on the risk-appetite variable. The results are robust to identifying the shocks through a Choleski decomposition (using various recursive orderings).

    In other words, there are two relevant transmission channels. First, there is the “traditional channel”, through which a growth shock in the U.S. (or euro area) induces capital to flow to the country in which the shock originates and causes an appreciation of the dollar (or the euro). Second, there is the “risk-appetite channel,” through which a real shock boosts investor risk-appetite—which increases capital flows to EMNS and leads to an appreciation of their currencies—as investors envisage better global economic prospects owing to stronger growth in the U.S. and/or euro area. Our results suggest that the second effect dominates—likely reflecting the size of portfolio outflows from EMNS relative to outflows from SAEs.

    For transmission channels of spillovers from monetary policy shocks, see Chen, Mancini-Griffoli, and Sahay (2014) and Chen, Mancini-Griffoli, and Saadi-Sedik (forthcoming).

    Recall that in our framework positive real shocks increase risk-appetite.

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