Volatility spillovers to the emerging financial markets during taper talk and actual tapering

On 22 May 2013, Fed chairman, Ben Bernanke surprised markets by indicating to the media that the US Fed may taper its quantitative easing programme. This set out financial volatility across the globe over the next several months that spilled over to the financial markets of emerging market economies (EMEs). It prompted many EME central banks to take varied policy actions. Looking into this widely known event, this article presents formal empirical evidence establishing that (i) conditional volatility during taper talk exceeded that during actual tapering and (ii) volatility spillovers took place ‘contemporaneously’ from the US markets to the key EMEs during this period. The results suggest importance of careful communications by advanced economy central banks and the possibility of establishing ‘rules of the monetary game’. They also suggest that in the absence of international policy coordination to contain spillovers, EME central banks should build adequate buffers and reinforce financial stability ahead of the reversal of the global interest rate cycle.     

Volatility Spillovers and Contagion from Mature to Emerging Stock Markets

This paper models volatility spillovers from mature to emerging stock markets, tests for changes in the transmission mechanism during turbulences in mature markets, and examines the implications for conditional correlations between mature and emerging market returns. Tri‐variate GARCH–BEKK models of returns in mature, regional emerging, and local emerging markets are estimated for 41 emerging market economies (EMEs). Wald tests suggest that mature market volatility affects conditional variances in many emerging markets. Moreover, spillover parameters change during turbulent episodes. In the majority of the sample EMEs, conditional correlations between local and mature markets increase during these episodes. While conditional variances in local markets rise as well, volatility in mature markets rises more, and this shift is the main factor behind the increase in conditional correlations. With few exceptions, conditional beta coefficients between mature and emerging markets tend to be unchanged or lower during turbulences.     

COVID-19, asset markets and capital flows

This paper empirically examines the reaction of global financial markets across 38 economies to the COVID-19 outbreak, with special focus on the dynamics of capital flows across 14 emerging market economies. The effectiveness of fiscal and monetary policy responses to COVID-19 is also tested. Using daily data over the period January 4, 2010 to August 31, 2020, and controlling for a host of domestic and global macroeconomic and financial factors, we use a fixed effects panel approach and a structural VAR framework to show that emerging markets have been more heavily affected than advanced economies. In particular, emerging economies in Asia and Europe have experienced the sharpest impacts on stock, bond and exchange rates due to COVID-19, as well as abrupt and substantial capital outflows. Quantitative easing and fiscal stimulus packages mainly helped to boost stock prices, notably for advanced and emerging economies in Asia. Our findings also highlight the role that global factors and developments in the world's leading financial centers have on financial conditions in EMEs. Importantly, the impact of COVID-19 related quantitative easing measures by central banks in advanced countries extended to EMEs, with significant positive spillovers to EME stock markets in Asia, Europe and Latin America. Going forward, while the ultimate resolution of COVID-19 may be expected to lead to a market correction as uncertainty declines, our impulse response analysis suggests that there may be persistent effects on bond markets in emerging Europe and on EME capital flows.     

The effect of US stress tests on monetary policy spillovers to emerging markets

This paper explores the transmission of US monetary policy through US banks to emerging market economies (EMEs) and the role that stress tests play in this transmission. Data on US banks’ monthly commercial and industrial loan originations shows that: (a) US bank lending to EMEs was sensitive to domestic monetary policy changes during the zero‐lower bound period. (b) Effects of monetary easing were heterogeneous across banks and depended on banks’ stress test results, a proxy for their capital strength. Only banks that comfortably passed the stress tests issued more loans to EME borrowers. (c) Effects of monetary tightening were more similar across banks. (d) Banks shifted their lending to safer borrowers within EMEs in response to monetary easing, leaving the risk of their overall loan books unchanged. These results support the hypothesis that bank capital affects the transmission of easier monetary policy, including across borders. We conjecture that bank lending to EMEs during the zero‐lower bound period would have been even higher had the United States not introduced stress tests for their banks.     

Information Transmission between Mature and Emerging Equity Markets During Normal and Crisis Periods: An Empirical Examination

In this paper, we examine the price discovery and volatility spillovers between eight mature market economies (MMEs) and eight emerging market economies (EMEs) from January 2003 to July 2014, covering three sub-periods—prior to the 2007–09 global financial crisis (GFC), during the crisis, and post-crisis. The results of price discovery indicate that MMEs lead EMEs in the pre-crisis and post-crisis periods. All MMEs are cointegrated with China in the pre-crisis period but not in the post-crisis period. Dynamic cointegration results reconfirm our findings from Johansen’s co-integration test. The asymmetric dynamic conditional correlation (ADCC-GARCH) coefficients suggest a regional pattern among MMEs and EMEs, except in the case of European MMEs with South Africa. Employing BEKK-GARCH model, we find that volatility spillovers of MMEs with China and of Italy with EMEs weakened in the post-crisis period as compared to the pre-crisis period implying that the GFC damaged the information transmission process, particularly for China and Italy. While China is a large economy with strong trade linkages with the rest of the world, Italy is one of the larger European economies which was in relatively greater distress during the EDC. The findings have implications for policy makers and investors.

     

Fed and ECB monetary policy spillovers to Emerging Market Economies

This paper presents evidence that the international spillovers of both Fed and ECB conventional monetary policies to Emerging Market Economies (EMEs) are global. The result comes from the panel Bayesian Vector Autoregressive (BVAR) model estimated for EMEs in which we control i.a. for foreign central banks’ policy shocks. Furthermore, in the separate BVAR model for Central and Eastern European (CEE) countries we show that the ECB is the main foreign central bank for these economies — after controlling for its shocks, their Fed counterparts play a very moderate role in driving GDP and prices in CEE.     

Macroprudential policy and the inward transmission of monetary policy: The case of Chile,Mexico, and Russia

This paper studies whether domestic macroprudential policy may attenuate the inward transmission of monetary policy shocks from the United States to domestic bank lending growth in three emerging market economies—Chile, Mexico, and Russia. Identification relies on banks’ heterogeneous exposure to prudential policies and the fact that foreign monetary policy shocks are exogenous from the perspective of these economies. After analyzing the effects of the aggregate domestic prudential policy stance, we focus on specific prudential policies targeting mortgage and consumer loans, as well as foreign‐currency deposits. Although our overall results are mixed, we find evidence that the strength of international monetary policy spillovers varies depending on the stance of domestic macroprudential policy. In particular, a tighter reserve requirement stance over foreign‐currency deposits in Chile dampens the effect of an international monetary policy shock on domestic local‐currency lending, but reinforces that on foreign‐currency lending, whereas in Russia, it dampens the effect on both local‐currency and foreign‐currency lending, although to different degrees. Prudential policies targeting the asset side of banks’ balance sheets, such as mortgage loans or consumer credit, are found to amplify international monetary policy spillovers in some cases and attenuate it in others, depending on the country context.     

Unemployment dynamics in emerging countries: Monetary policy and external shocks

This paper quantifies the impact of three key external shocks – external demand, interest rate, and uncertainty shocks – on emerging market economies (EMEs). We find that external shocks have a sizeable impact on macroeconomic fluctuations in EMEs and that a considerable fraction of this impact is through the domestic stock market. A decrease in external demand and an increase in external interest rate and uncertainty lead to a higher unemployment rate, lower stock market return, and a depreciation of the domestic currency. The EMEs' monetary policy actively responds to external shocks and dampens their impact on domestic activity.     

External monetary shocks and monetary integration: Evidence from the Bulgarian currency board

Starting July the 1st 1997, Bulgaria adopted a Currency Board (CB) monetary system. This paper aims at investigating if the adoption of the CB monetary system, which involves the cost of losing monetary autonomy, has provided a relatively better (with respect to other CEEC) monetary integration of Bulgaria with the European Monetary Union (EMU). Since Bulgarian monetary variables are endogenous under a CB, we focus on the ECB and FED interest rates as the main sources on monetary volatility. First, we find that ECB shocks are more rapidly absorbed and have less significant impact of domestic variables, with respect to other external monetary shocks (FED rate changes). Second, the responses of Bulgarian variables following changes in the ECB interest rate present lower persistence and significance, with respect to what the previous literature emphasized for other CEEC with monetary autonomy. This latter result still holds when accounting for different sources of cross-country heterogeneity outlined in the literature, thus supporting that the adoption of the CB may have worked as a rather good device in terms of integration of Bulgaria into the EMU.     

News and correlations of CEEC-3 financial markets

We employ DCC-MGARCH models to investigate conditional correlations between six CEEC-3 financial markets. In general, the highest correlations exist between Hungary and Poland in foreign exchange and stock markets. Short-term money markets are somewhat isolated from each other. We find that the associations of CEEC-3 exchange rates versus euro are weaker than those versus the US dollar. The persistence of the effect of shocks on the time-varying correlations is strongest for foreign exchange and stock markets, indicating a tendency toward contagion. In searching for the origins of financial market volatility in the CEEC-3, we uncover some evidence of Granger-causality on the foreign exchange markets. Finally, using a pool model, we investigate the impact of euro area, US, and CEEC-3 news on the correlations. Apart from ECB monetary policy news, we observe no broad effects of international news on correlations; instead, local news exerts an influence, which suggests a dominance of country- or market-specific circumstances.     

Oil and the Euro area economy

We examine the macroeconomic effects of different types of oil shocks and the oil transmission mechanism in the Euro area. A comparison is made with the US and across individual member countries. First, we find that the underlying source of the oil price shift is crucial to determine the repercussions on the economy and the appropriate monetary policy reaction. Second, the transmission mechanism is considerably different compared to the US. In particular, inflationary effects in the US are mainly driven by a strong direct pass-through of rising energy prices and indirect effects of higher production costs. In contrast, Euro area inflation reacts sluggishly and is much more driven by second-round effects of increasing wages. The monetary policy reaction of the ECB to oil shocks is also strikingly different compared to the FED. The inflation objective, relative to the output stabilization objective, appears more important for Euro area monetary authorities than for the FED. Third, there are substantial asymmetries across member countries. These differences are due to different labour market dynamics which are further aggravated by a common monetary policy stance which does not fit all.
--- Gert Peersman and Ine Van Robays     

Financial cycles in asset markets and regions

This paper provides a comprehensive analysis of financial cycles in asset markets and regions. Using a large sample of 38 advanced and emerging economies to enable a comparative assessment, the analysis conforms with the prevailing literature pertaining to the characterization of financial cycles in advanced economies, but finds that equity market cycles in emerging market economies (EMEs) in Asia, Latin America, and Eastern Europe may be a more useful gauge of the financial cycle compared to cycles in credit and property markets. Similar to more advanced economies, it is found that financial and business cycles in emerging economies are synchronized, albeit partially and with some cross-country heterogeneity. This underscores the importance for policy makers to be vigilant of interlinkages between real and financial sectors, pointing toward a need for carefully designed macroprudential policies. Finally, it is found that financial cycles in emerging markets remain vulnerable to global risk aversion in financial markets and spillovers from the US, thereby reinforcing the importance of continuing to strengthen domestic macroeconomic fundamentals, and develop further local financial sectors through targeted structural reforms.     

International spillovers from US forward guidance to equity markets

We quantify the international spillovers of explicit Federal Open Market Committee (FOMC) policy rate guidance used as an unconventional monetary policy tool at the zero lower bound of the policy rate on international equity markets, considering equity indices of both advanced and emerging economies. We find that stimulatory explicit FOMC policy rate guidance announcements at the zero lower bound led to higher equity prices in a number of advanced and emerging economies. Moreover, we find that equity indices of economies with lower sovereign ratings rose by more, consistent with the risk-taking channel of monetary policy.     

Spatial spillovers in emerging market spreads

We use novel spatial econometrics techniques to explore spillovers in the sovereign bond market for 24 emerging economies during 1995–2010. The article extends the previous literature focusing on spillover effects from advanced to emerging economies by analyzing transmission of shocks across emerging markets. After controlling for the impact of global factors, we find strong evidence of spillovers from both sovereign spreads and macroeconomic fundamentals in neighboring emerging economies. In addition to the geographical proximity, the channels of spatial transmission include trade and financial linkages. The results of the article highlight the importance of accounting not only for spillovers from advanced economies to emerging markets but also across emerging markets when analyzing sovereign spreads.     

Impacts of China's crash on Asia-Pacific financial integration: Volatility interdependence,information transmission and market co-movement

This paper examines the price and volatility dynamics between China and major stock markets in the Asia-Pacific, investigating the effects of the Chinese stock market crash (2015–2016) for the first time. Employing the Bayesian VAR and BEKK GARCH, we observe that price and volatility spillover behaviours are different during the stable and stress periods. Particularly, price spillovers from China to other regional markets are more significant during a bullish period, showing that ‘good news’ emanating from China has strong impacts on its neighbours during better market condition. In the turbulent period, we observe strong shock spillover effects and enhanced volatility spillovers from China to most Asia-Pacific stock markets. This is because China, as an important trading partner and strategic financial centre shows to exert significant influence on the Asia-Pacific region through various economic channels. We also find that the Asia-Pacific stock markets spill over their shocks to China during the crisis, indicating that China is becoming more integrated with the regional financial markets.     

Cross-country fiscal policy spillovers and capital-skill complementarity in integrated capital markets

The 2010 European sovereign debt crisis has renewed discussions on fiscal policy coordination. One rationale for coordination is fiscal policy cross-country spillovers. A common finding in the literature is that spillovers tend to be small in normal circumstances but can be large if monetary policy is at the zero lower bound. Orthogonal to the existing literature, we document a novel channel that generates cross-country spillovers over the medium run. We assume perfect capital markets integration and find that capital-skill complementarity can lead to large spillovers without the zero lower bound nor a large import share in government expenditures. As capital markets have become increasingly integrated in the Eurozone, the current degree of fiscal policy coordination between its members, low, may be insufficient. We also find that the smoothing benefits from a temporary rise in public debt spill over to other countries.     

Fiscal response to the COVID-19 crisis in advanced and emerging market economies†

The fiscal policy response to the COVID-19 crisis was swift and strong, in tandem with monetary policy. Advanced economies (AEs) deployed a much larger fiscal response than emerging market economies (EMEs) throughout the pandemic. This study focuses on the drivers of this divergent fiscal response in the first months of the pandemic. Apart from the fact that EMEs entered the crisis later than AEs, narrower fiscal policy space in EMEs, further reduced by the tightening of their financing conditions in the early stages of the pandemic, constrained their fiscal response. The size and composition of the fiscal response also depended on some structural factors, such as the level of income, the strength of the social safety nets and automatic stabilisers.     

Do China and oil exporters influence major currency configurations?

This paper analyses the impact of the shift away from a US dollar focus of systemically important emerging market economies (EMEs) on configurations between the US dollar, the euro and the yen. Given the difficulty that fixed or managed US dollar exchange rate regimes remain pervasive and reserve compositions mostly kept secret, the identification strategy of the paper is to analyse the market impact on major currency pairs of official statements made by EME policy-makers about their exchange rate regime and reserve composition. Developing a novel database for 18 EMEs, we find that such statements not only have a statistically but also an economically significant impact on the euro, and to a lesser extent the yen against the US dollar. The findings suggest that communication hinting at a weakening of EMEs’ US dollar focus contributed substantially to the appreciation of the euro against the US dollar in recent years. Interestingly, EME policy-makers appear to have become more cautious in their communication more recently. Overall, the results underscore the growing systemic importance of EMEs for global exchange rate configurations.     

Global financial crisis as a phenomenon of stock market overshooting

Inspired by Dornbusch’s model of exchange rate overshooting we develop a theory of stock market behaviour and its impact on the real economy. The idea is that stock market prices overshoot and undershoot their long-run equilibrium values which are determined by the development in the real economy. The overshooting is triggered primarily by a loose monetary policy. With our model we explain the genesis of the global financial crisis (GFC) 2008/2009 primarily as the result of a loose monetary policy in the USA. Following the overshooting and crash in the stock market the real economy dropped into a recession. After modelling the interaction of three markets with different speed of adjustment—money, stocks and goods—for a closed economy we expand it to an open economy and lastly study the spillovers of a financial market crisis between countries (from a large to a small country) by introducing the transmission channels of external trade or cross-border financial transactions. A long-lasting monetary easing as exhibiting by the Fed and the ECB since 2007 and 2008, respectively could—according to our model—generate another boom-bust cycle.     

The effectiveness of monetary policy in steering money market rates during the financial crisis

The financial crisis has deeply affected money markets and thus, potentially, the proper functioning of the interest rate channel of monetary policy transmission. Therefore, we analyze the effectiveness of monetary policy in steering euro area money market rates by looking at (i) the predictability of money market rates on the basis of monetary policy expectations and (ii) the impact of extraordinary central bank measures on money market rates. We find that during the crisis money market rates up to 12 months still respond to revisions in the expected path of future rates, even though to a lesser extent than before August 2007. We attribute part of the loss in monetary policy effectiveness to money market rates being driven by higher liquidity premia and increased uncertainty about future interest rates. Our results also indicate that the ECB’s non-standard monetary policy measures as of October 2008 were effective in addressing the disruptions in the euro area money market. In fact, our estimates suggest that non-standard monetary policy measures helped to lower Euribor rates by more than 80 basis points. These findings show that central banks have effective tools at hand to conduct monetary policy in times of crises.