Financial Globalisation, Monetary Policy Spillovers and Macro-Modelling: Tales from 1001 Shocks

Financial globalisation and spillovers have gained immense prominence over thelast two decades. Yet, powerful cross-border financial spillover channels have notbecome a key theme in structural monetary models. Against this... [ view full abstract ]

Financial globalisation and spillovers have gained immense prominence over the
last two decades. Yet, powerful cross-border financial spillover channels have not
become a key theme in structural monetary models. Against this background,
we hypothesise that New Keynesian DSGE models that do not feature powerful
financial spillover channels confound the effects of domestic and foreign disturbances when confronted with the data. We derive predictions from this hypothesis and subject them to data on monetary policy shock estimates for 28 economies obtained from more than 250 monetary models in the literature. Consistent with the predictions from our hypothesis we find: Monetary policy shock estimates obtained from New Keynesian DSGE models that do not account for powerful financial spillover channels are contaminated by a common global component; the contamination is more pronounced for economies that are more susceptible to financial spillovers in the data; and the shock estimates imply implausibly similar estimates for the global output spillovers from monetary policy in the US, the euro area and the UK. None of these findings applies to monetary policy shock estimates obtained from VAR and other statistical models, financial market expectations and the narrative approach.