ECB's Monetary Policy in Light of the Fed's Policy Stance

Hauzenberger, Niko and Huber, Florian and Zörner, Thomas (2024) ECB's Monetary Policy in Light of the Fed's Policy Stance. SUERF Policy Brief (No 838). The European Money and Finance Forum.

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Abstract

The secular rise in globalization has led to a substantial increase in the interconnectedness of global financial markets. This has important implications for the conduct of monetary policy, as central bank policies may diverge across countries, potentially affecting key transmission channels of domestic policy actions. In this study, we propose a novel nonlinear multivariate time series model with weekly data to examine the influence of U.S. monetary policy on the transmission of monetary policy in the euro area. Scenario-specific impulse responses show that the transmission of euro area monetary policy through financial markets does indeed depend on the prevailing monetary policy regime of the Federal Reserve and has significant effects on a variety of euro area financial market variables. Our approach enables us to examine how the term structure of real interest rates responds to ECB monetary policy shocks, contingent upon the prevailing U.S. monetary policy regime. Our analysis reveals that hawkish ECB surprises elicit a stronger increase of short-term real government bond yields when the Fed’s stance aligns with hawkishness, compared to situations where monetary policies diverge.

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