THE PUZZLING CHANGE IN THE INTERNATIONAL TRANSMISSION OF U.S. MACROECONOMIC POLICY SHOCKS

Ethan Ilzetzki and Keyu Jin, London School of Economics
Journal of International Economics, Accepted.

Abstract

Using five separate identification methods, we demonstrate a dramatic change over time in the international transmission of US macroeconomic shocks. International spillovers from US monetary policy, government spending, and tax policy shocks take on a different nature the 21st century than they did in post-Bretton Woods period. Our analysis is based on the a panel of 17 high income and emerging market economies. Prior to the 1990s, the US dollar appreciated, and ex-US industrial production declined, in response to increases in the US Federal Funds rate, as predicted by textbook open economy models. Similarly, fiscal policies leading to interest rate increases appreciated the dollar and lead to output contractions. The past three decades have seen a shift, whereby increases in US interest rates depreciate the US dollar but stimulate the rest of the world economy. We sketch a simple theory of exchange rate determination in face of interest-elastic risk aversion that rationalizes these findings.