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Instrumenting US monetary shocks with fed funds future contracts and extracting global risk sentiment from VIX, this paper uses a structural vector autoregression framework to estimate the causal impact of US monetary policy on New Zealand financial and real sectors. The paper finds that 20 basis points increase in US one-year rate leads to about 14 and 59 percent increase in domestic and external funding spreads of New Zealand banks, respectively. The paper also finds that credit default swap spread rises contemporaneously following a US monetary tightening shock. Similar patterns are documented in Australia, Canada, Sweden and United Kingdom. These results suggest the existence of a global financial cycle underpinned by US monetary policy, and prompt the reassessment of the relevance of Mundellian trilemma in an increasingly globalised economic system.
The author is grateful to Daniel Wills, Benjamin Wong, and Eilya Torshizian for helpful suggestions. He is also very grateful for the comments and guidance offered by Tim Ng.
The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author(s). They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government. The New Zealand Treasury and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate.