Heterogeneous effects in the international transmission of the US monetary policy: a factor-augmented VAR perspective

Abstract

This paper analyses the international transmission of US monetary policy shocks. We use a time-varying, factor-augmented VAR framework to examine how and to what extent the propagation of US policy shocks affects the South East Asian (SEA) and European Union (EU) economies, through various transmission channels. We find that in the SEA economies, the income absorption effect is the most pronounced channel as indicated by the significant worsening of the trade balance of these countries, which provokes a reduction in their output. In addition, wealth effects and the balance sheet channel have an important contribution in the transmission of the shock to these economies. In the EU, the initial rise observed in output as a result of the shock is driven more by exchange rate movements rather than movements in the trade balance. In terms of changes in the magnitude of the effect of the shock over time, we find that the deepening of global integration dampens the effect of the shock on the foreign economies in core macroeconomic and financial variables. Moreover, the impact of the shock on the foreign economies has increased in the post-crisis period.