Appendix A –Evolution of the domestic variables and spillovers to EMs
A monetary shock in the baseline model leads to a reduction in domestic GDP growth, risk appetite and bank leverage on impact. While GDP growth starts to recover a few quarters after the shock (4 in the case of the EA and 6 in the case of the US), the negative effect on bank leverage is more protracted, lasting about 12 quarters in both countries (See top part of Figure A1). In other words, this type of shock increases the financing cost for firms and households, reducing the demand for credit, and thus GDP growth. Regarding the international effects, an exogenous increase in the term spread in either the US or EA leads to lower GDP growth and weaker currencies in emerging economies, but the effects fade after 6 quarters. The decline in aggregate demand in the US or EA brought about by the monetary tightening in these economies, reduces the demand of exports from emerging economies, thus adversely affecting their growth prospects and weakening their currencies (See bottom of Figure A1).
Our results indicate that an autonomous shock to aggregate demand in the US or the EA leads to higher GDP growth, and increases the domestic demand for credit, inducing banks to leverage- up to meet the additional demand for funds. Domestic risk-aversion declines in the first few quarters after the shock, reflecting agents’ willingness to take more risk on the back of improved economic conditions. We also observe a decline in the domestic term-spread, as short-term rates
likely increase due to countercyclical monetary policy,16 and they likely do so more than long- term rates, because these are affected by other long-term macroeconomic factors (e.g., savings productivity, etc.). Increased demand in the US or EA translates into to higher GDP growth rates in EMs, albeit with a lag (see Figure A2).
A decline in leverage lead to a reduction in domestic GDP growth, as well as increases in risk appetite and term spread on impact. While US GDP growth starts to steadily recover a few quarters after the shock (6 quarters), the evolution in EA is more volatile (See top part of Figure A3). Regarding the international effects, an exogenous decline in leverage in either the US or EA leads to lower GDP growth, with the effects fading after a few years (See bottom of Figure A3).
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