WP/15/85. Financial Crisis, US Unconventional Monetary Policy and International Spillovers. by Qianying Chen, Andrew Filardo, Dong He, and Feng Zhu

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1 WP/15/85 Financial Crisis, US Unconvenional Moneary Policy and Inernaional Spillovers by Qianying Chen, Andrew Filardo, Dong He, and Feng Zhu

2 2015 Inernaional Moneary Fund WP/15/85 IMF Working Paper European Deparmen Financial Crisis, US Unconvenional Moneary Policy and Inernaional Spillovers 1 Prepared by Qianying Chen, Andrew Filardo, Dong He, and Feng Zhu 2 Auhorized for disribuion by Bas Bakker April 2015 IMF Working Papers describe research in progress by he auhor(s) and are published o elici commens and o encourage debae. The views expressed in IMF Working Papers are hose of he auhor(s) and do no necessarily represen he views of he IMF, is Execuive Board, or IMF managemen. Absrac We sudy he impac of he US quaniaive easing (QE) on boh he emerging and advanced economies, esimaing a global vecor error-correcion model (GVECM) and conducing counerfacual analyses. We focus on he effecs of reducions in he US erm and corporae spreads. Firs, US QE measures reducing he US corporae spread appear o be more imporan han lowering he US erm spread. Second, US QE measures migh have prevened episodes of prolonged recession and deflaion in he advanced economies. Third, he esimaed effecs on he emerging economies have been diverse bu ofen larger han hose recorded in he US and oher advanced economies. The heerogeneous effecs from US QE measures indicae unevenly disribued benefis and coss. 1 The views expressed are hose of he auhors and do no necessarily represen he views of he Bank for Inernaional Selemens or he Inernaional Moneary Fund. We very much appreciae he commens by he journal referee, and he commens on he drafs of his and earlier versions from Jonahan Baen, Menzie Chinn, Dierich Domanski, Alex Heah, Roong Mallikamas, Richhild Moessner, Shinobu Nakagawa, Parizio Pagano, Eswar Prasad, John Taylor, Bernhard Winkler and he paricipans a he 9h Annual Hong Kong Insiue for Moneary Research Summer Workshop, he 2011 Join Workshop on Emerging Markes of he European Cenral Bank and he Deusche Bundesbank, he 2012 EEA-ESEM meeing, he Bank of Canada 2013 conference on Inernaional macroeconomic policy cooperaion: challenges and prospecs, he Bank of Korea Seminar on Macro-financial linkages and macro-prudenial policies and he ECB-IMF conference on Inernaional dimensions of convenional and unconvenional moneary policy. 2 Qianying Chen, Inernaional Moneary Fund (IMF), Andrew Filardo, Bank for Inernaional Selemens (BIS), Dong He, IMF, Feng Zhu, BIS, Dong He was a saff member of he Hong Kong Moneary Auhoriy (HKMA) when he worked on his paper.

3 2 JEL Classificaion Numbers: E44, E52, E65, F42, F47 Keywords: emerging economies; financial crisis; global VAR; inernaional moneary policy spillovers; quaniaive easing; unconvenional moneary policy Auhor s Address: (Q. Chen), (A. Filardo), (D. He), (F. Zhu)

4 3 Conen I. Inroducion 4 II. Esimaing he Effecs of US Unconvenional Policies 6 A. GVECM Analysis: Model and Variables 6 B. GVECM Analysis: Impulse Responses 9 C. Cross-Border Moneary Policy Spillovers 11 III. GVECM-based counerfacual analysis 16 A. Spillovers From Reducions in he US Corporae Spread 19 IV. Conclusion 22 Appendices I: Srucure of he GVECM Model 24 II: Foreign Exchange Pressure Index 26 III: Time-Varying Weighs for Foreign Variables 27 IV: Daa 28 References 29 Figures 1. Impulse Responses o US Term and Corporae Spread Shocks: Unied Saes Maximum Impulse Responses o a US Corporae Spread Shock Disribuion of Maximum Impulse Responses o US Term and Corporae Spread Shocks Counerfacual Analysis of Domesic US QE Impac: US Corporae Spread Counerfacual Analysis of Euro Area Impac: US Corporae Spread Counerfacual Analysis of Impac in Brazil: US Corporae Spread Counerfacual Analysis of Impac in China: US Corporae Spread 22 Table 1. The Federal Reserve s Large-Scale Asse Purchase (LSAP) Programs 5

5 4 I. INTRODUCTION 1. The US subprime morgage crisis and he Grea Recession have had a major impac on he design and implemenaion of moneary policy. Following he crisis, he Federal Reserve lowered he federal funds rae arge rapidly o near zero, and has aken addiional measures considered unconvenional (Table 1). 2. The unconvenional policy acions aken by cenral banks in a number of major economies have led o a burgeoning lieraure on heir effeciveness. Mos work has focused on heir domesic effecs and relied on even sudies analysing he announcemen effecs of quaniaive easing (QE) on asse prices: some sudies have also employed regression analysis. Among ohers, D Amico and King (2010), Doh (2010), Gagnon, Raskin, Remache and Sack (2010, 2011), Joyce, Lasaosa, Sevens and Tong (2011), Krishnamurhy and Vissing-Jorgensen (2011) and Meaning and Zhu (2011, 2012) provide esimaes for he Federal Reserve s and he Bank of England s large-scale asse purchase programs. 3. A beer undersanding of he moneary policy spillovers associaed wih QE measures may help policymakers o cope wih he challenges posed by such policies and o assess he need for inernaional policy coordinaion. Ye we know very lile abou he impac of he unconvenional policies on real aciviy, and so far here has been lile research on heir cross-border spillovers, especially on emerging economies Several sudies examine he cross-border financial marke impac of QE policies. Relying on even sudies of US asse purchases, Neely (2010) finds ha US QE lowered bond raes in he oher advanced economies by basis poins and depreciaed he US dollar by 4-11 percen. Glick and Leduc (2012) show ha commodiy prices on average fell upon he announcemens of US asse purchases, despie a decline in long-erm ineres raes and US dollar depreciaion. Chen, Filardo, He and Zhu (2012, 2014a) and Rogers, Scoi and Wrigh (2014) provide evidence on he inernaional spillovers of he unconvenional measures implemened by he Bank of England, he European Cenral Bank, he Federal Reserve and he Bank of Japan. Frazscher, Lo Duca and Sraub (2013) find ha earlier US QE measures were highly effecive in lowering sovereign yields and raising equiy prices. Bu since 2010 such measures have had a mued impac on yields across counries. Chen, Filardo, He and Zhu (2014b) inroduce esimaed shadow federal funds raes in a global VAR o assess he domesic and global impac of US unconvenional moneary policy. They find ha US QE migh no have only prevened US recessions bu also had subsanial global spillovers. IMF (2013a, b) finds ha unconvenional moneary policies have successfully resored marke funcioning and inermediaion in he early phase of he global financial crisis, bu heir coninuaion carries risks. 5. There are wo major views on he spillovers of he unconvenional moneary policies implemened in he major advanced economies. The firs view considers ha such policies 3 To assess he macroeconomic effecs of QE measures, Chen, Filardo, He and Zhu (2012, 2014a, b) esimae a global VAR model and Gambacora, Hofmann and Peersman (2012) employ a panel VAR model. Hofmann and Zhu (2013) sudy he effecs on inflaion expecaions of Federal Reserve asse purchases and find hese were well-anchored and such purchases had lile impac.

6 5 are designed for domesic coningencies; any spillovers are uninended and primarily an issue for oher policymakers o address. This echoes he Obsfeld-Rogoff (2002) proposiion ha here are only small gains from policy coordinaion once individual cenral banks implemen policies opimised o achieve domesic macro sabiliy. Moreover, Osry and Ghosh (2013) consider uncerainies and disagreemen abou he cross-border effecs of QE policies a major obsacle o policy coordinaion. Table 1. The Federal Reserve s Large-Scale Asse Purchase (LSAP) Programs Announcemen Terminaion Asses purchased Amoun 1 LSAP1 Nov Agency morgage-backed securiies (MBS) and agency deb $600 billion Mar Agency securiies $850 billion Mar Longer-erm US Treasury securiies LSAP2 Nov Jun Longer-erm US Treasury securiies Mauriy exension program (MEP) Sep US Treasury securiies wih remaining mauriies of six o 30 years Jun Dec US Treasury securiies wih remaining mauriies of six o 30 years $300 billion $600 billion $400 billion LSAP3 Sep Oc Agency MBS $40 billion per monh 2 Dec Oc Longer-erm US Treasury securiies $45 billion per monh 2 1 Iniially announced amoun of asse purchases for each program or program expansion. 2 The purchases were open-ended when hey were announced. The Federal Reserve sared o aper he asse purchases in January 2014, and evenually haled he purchases alogeher in Ocober Source: US Federal Reserve. 6. The second view argues ha QE policies are less benign. Amongs oher hings, hey depreciae domesic currencies and inflae risk-adjused ineres rae differenials vis-à-vis oher economies, leading o poenially large capial inflows and consumer and asse price inflaion pressures abroad. Besides concerns wih compeiive devaluaion, Rajan (2013) highlighs he poenial danger of compeiive asse price inflaion. Taylor (2013) poins ou ha, while he Obsfeld-Rogoff (2002) proposiion may be rue in normal imes, sizeable cross-border spillovers seen in recen years have changed he cos-benefi analysis. This would paricularly be he case if QE measures represen deviaions from rules-based policy which creae incenives for oher cenral banks o deviae from rules-based policies. The cross-border effecs of QE may also be perceived as beneficial or harmful by hose affeced, depending in large par on he cyclical posiion hey find hemselves in a he ime when QE is adoped. There is a general consensus ha ha during he global financial crisis and he ensuing recession, QE policies helped o sabilize global financial markes and prevened an even furher collapse in he global economic aciviy. As recovery languished in he advanced economies bu gahered pace in he emerging economies, QE arguably conribued o

7 6 economic overheaing and asse marke excesses in some jurisdicions owing o he large currency appreciaion and capial inflow pressures In his paper, we sudy he macroeconomic effecs of QE, boh domesic and inernaional, esimaing a global vecor error correcion model (GVECM) covering 17 advanced and emerging economies, using monhly daa spanning Given he size of he GVECM and he limied daa span, he elevaed esimaion uncerainy is refleced in he relaively large confidence bands. Our esimaes sugges ha he cross-border spillovers varied across economies and over ime. We find ha reducing he US corporae spread, and, o a lesser exen, he US erm spread, had sizeable effecs on financial condiions and economic aciviy boh domesically and globally. Taken a face value, our counerfacual analysis indicaes ha US QE programs, especially LSAP1, were imporan couner-cyclical measures, apparenly prevening he US and oher advanced economies from prolonged recession and deflaion. 8. The effecs of US QE measures on he emerging economies are esimaed o be generally larger and more diverse han hose in he advanced economies. In our view, he srengh of he effecs depends parly on how each economy reacs o he US policy shocks, and parly on he disinc economic and financial srucures, policy frameworks and exchange rae arrangemens. Our esimaes also sugges ha US QE measures conribued o overheaing in Brazil, China and some oher emerging economies in 2010 and 2011, bu suppored recovery in hese economies in 2009 and The diverse cross-border QE effecs imply ha he coss and benefis of US QE policies have been unevenly disribued beween he advanced and emerging economies and have varied over ime. 9. The paper is organized as follows. Secion 2 describes he GVECM and provides empirical resuls on he cross-border impac of US QE measures wih impulse responses o a US erm or corporae spread shock esimaed from a GVECM. Secion 3 examines he domesic and spillover effecs of US QE measures on financial and real aciviies, assessed wih a counerfacual analysis based on he impulse response esimaes. Secion 4 concludes. II. ESTIMATING THE EFFECTS OF US UNCONVENTIONAL POLICIES 10. To assess he domesic and foreign effecs of US unconvenional policies on real and financial aciviies, we employ a global vecor error correcion model (GVECM), developed by Pesaran, Schuermann and Weiner (2004), which is suied for capuring cross-border macro-financial linkages. We firs esimae impulse responses for each economy using he GVECM. Based on hese, we design counerfacual scenarios in which US QE measures are assumed o be absen, and evaluae heir effecs by comparing he no-qe projecions o acual daa. A. GVECM Analysis: Model and Variables 11. The model is srucured as follows. 5 For economy i, he model VECM * can be wrien as: 4 See BIS (2012) and De Nicolò, Dell Ariccia, Laeven and Valencia (2010).

8 7 pi 1 r i 1 ~ 0 i c1 i Π zi, 1 Ψis zi, s Γi xi is ds i, s1 s0 x i c ε (1) iid wih ~ 0 i, i ε, zi ( ' x *', x i i ' ), and ~ z i ' *' ' ( x, x, d ) (2) i i where is he observed global facor, e.g. he CBOE Volailiy Index (VIX). For every non-us economy i, we have and x ( y mp bc sp emp ) (3) i i i i i i * x y mp bc sp emp ) (4) i ( i, i, i, i, i, i, 12. Each counry VECM consiss of six domesic endogenous variables: real GDP growh ( y), he CPI inflaion rae (π), a moneary policy indicaor (mp), credi growh ( bc), equiy price (sp) and foreign exchange pressure index (emp). The model is hen augmened wih a se of foreign variables which include, e.g. foreign real GDP growh and he VIX. 6 Excep for he VIX, he foreign variables are consruced as he weighed averages of he corresponding variables in all oher economies, and hey are assumed o be weakly exogenous. 13. For he US bloc, we include he same se of domesic variables as in he oher economies, bu only he non-us real GDP growh as a foreign variable. Given he imporance of he Unied Saes in he global economy, we do no rea he oher foreign variables, especially he financial variables, as weakly exogenous in he US bloc. Therefore he VIX is reaed as endogenous in he US bloc: x, (,,,,,, ) US yus US mpus bcus spus empus vix (5) i and * US, y US, x (6) 14. Blinder (2010) suggess ha cenral banks use unconvenional ools o reduce ineres rae spreads such as erm premiums and/or risk premiums, buying long-erm Treasuries or using QE o arge risk or liquidiy spreads. The raionale is ha since privae borrowing, lending, and spending decisions presumably depend on (risky) non- Treasury raes, reducing heir spreads over (riskless) Treasuries reduces he ineres raes ha maer for acual ransacions even if riskless raes are unchanged. We herefore describe he Federal Reserve s unconvenional measures, especially he large-scale purchases of 5 We provide furher deails on he srucure of he GVECM and on variables and daa in Appendices A-D. 6 The VIX, a key measure of marke expecaions of near-erm volailiy conveyed by S&P 500 sock index opion prices, provides a good measure of financial marke developmens.

9 8 sovereign (e.g. Treasuries) and privae (e.g. agency MBS) asses, wih wo moneary policy indicaors : he US erm spread beween he 10-year and hree-monh Treasury yields; and he US corporae spread beween he BofA Merrill Lynch US corporae AAA bond yield and he effecive federal funds rae. 15. Admiedly, he erm and corporae spreads may reflec informaion beyond ha capured by US moneary policy, given ha hese spreads are imporan baromeers of US financial secor healh. Bu even in normal imes, he erm spread is considered a useful indicaor, as cenral banks ac o shape expecaions of a specific ineres rae pah well ino he fuure. A he zero lower bound (ZLB), he funds rae loses is informaion conen; however, he wo spreads coninue o reflec he immediae objecives (and impac) of US QE measures, namely, o reduce longer-erm Treasury yields, lower borrowing coss for corporaes and households and resore credi flows. Purchasing Treasuries and agency MBS are expeced o reduce long-erm Treasury yields direcly and corporae bond yields via porfolio rebalancing For he oher advanced economies, which have faced he ZLB and implemened unconvenional measures, we use he spread beween 10-year and hree-monh governmen bond yields for he Unied Kingdom and Japan as he moneary policy indicaor, and he spread beween he 10-year governmen bond yield and he main refinancing rae for he euro area. For he emerging economies, we describe moneary policy wih he growh raes in a broad moneary aggregae, as heir cenral banks end o use a wide range of policy ools and a broad moneary aggregae may be he more robus indicaor for moneary policy. 17. We measure sress on an economy s currency by compuing an exchange rae pressure index as a weighed average of changes in he nominal effecive exchange raes and in foreign exchange reserves. The index is a varian of he index proposed by Eichengreen, Rose and Wyplosz (1995), aking ino accoun differen exchange rae regimes as well as policy inervenions by he respecive governmens. 18. One noable feaure is our modelling of cross-counry linkages using boh he financial and rade linkages, similar o Chen, Gray, N Diaye, Oura and Tamirisa (2010) and Eickmeier and Ng (2011). We gauge he srengh of he ime-varying financial inerdependence across economies based on he flow daa from he Bank for Inernaional Selemens (BIS) consolidaed bank lending saisics. In he consrucion of he foreign variables for an economy, he weighs on rade and financial linkages are deermined by he relaive imporance of rade and financial flows in ha economy (see Appendix C). Our robusness analysis indicaes ha varying heir relaive weighs does no significanly change he resuls. 7 Chen, Filardo, He and Zhu (2012) use corporae and erm spread reducions o sudy he impac of US QE measures, and Kapeanios, Mumaz, Sevens and Theodoridis (2012) and Pesaran and Smih (2012) evaluae he effecs of UK QE approximaing i wih a 100-basis-poin reducion in UK erm spreads or in he medium- o long-erm governmen bond yields.

10 9 19. In addiion, we use a new series of BIS oal credi o he non-financial privae secor. 8 The BIS series on average has a span of 45 years and is available for 40 advanced and emerging economies. 9 The daabase accouns for credi from all sources, no only ha exended by domesic banks. B. GVECM Analysis: Impulse Responses 20. To esimae he impulse responses, we idenify he moneary policy shocks using a recursive Cholesky scheme, wih he following ordering of he endogenous variables in he US VECM: real GDP growh, CPI inflaion, moneary policy indicaor, VIX index, equiy price inflaion, credi growh, and foreign exchange pressure. The ordering is consisen wih he exising VAR lieraure. Having explored a number of alernaive orderings, we find our resuls largely robus. In addiion, we follow Dees, di Mauro, Smih and Pesaran (2007) by assuming ha he US economy affecs bu does no respond o developmens in oher economies conemporaneously. This is equivalen o placing he US model as he firs counry bloc in he GVECM. 21. We esimae wo differen GVECMs, one wih he erm spread as he moneary policy indicaor for he advanced economies, he oher wih he corporae spread. Correspondingly, we have wo ses of resuls, one for he US moneary policy shock in erms of he erm spread and he oher in erms of he corporae spread. 22. The GVECMs are esimaed for he crisis period saring from he oubreak of he US subprime morgage crisis in July 2007 o February 2013, 10 for four advanced economies: he Unied Saes, he euro area, Japan and he Unied Kingdom; nine emerging Asian economies: China, Hong Kong SAR, India, Indonesia, Souh Korea, Malaysia, he Philippines, Singapore and Thailand; and four Lain American economies: Argenina, Brazil, Chile and Mexico. Domesic effecs of US erm and corporae spread shocks 23. Figure 1 presens wo ses of impulse responses for he US economy. One se refers o responses o a one-sandard-deviaion cu in he US erm spread of 14.2 basis poins, he oher o a one-sandard-deviaion (20.7 basis poins) reducion in he US corporae spread. 8 The privae non-financial secor includes non-financial corporaions (boh privae- and public-owned), households and non-profi insiuions serving households as defined in he Sysem of Naional Accouns In erms of financial insrumens, credi covers loans and deb securiies. 9 Deails of he new BIS credi series can be found a: Also see Dembiermon, Drehmann and Muksakunraana (2013). 10 We focus on he period following he crisis, when he Federal Reserve implemened unconvenional moneary policy measures. This sample period beer capures he more recen domesic and inernaional ransmissions, which migh have changed afer he crisis. Chen, Filardo, He and Zhu (2012, 2014a) provide esimaes for he pre-crisis period from February 1995 o June 2007.

11 Noably, as in many sudies based on he global VAR models, he confidence bands end o be wide. 11 This is largely due o he limied degrees of freedom in he esimaion wih many variables having relaively shor ime spans. Our confidence bands are subjec o he same limiaion, since we focus on he crisis period where he daa sample is very shor and he economic and policy uncerainies are paricularly elevaed. 12 To improve accuracy, we exclude from he esimaion of each counry model hose foreign variables considered less likely o affec or be affeced by he economy. 25. Several ineresing resuls emerge. Firs, US credi growh begins o have a saisically significan and persisen posiive response o a erm spread shock in six monhs ime: a credi channel migh be presen as a 14.2-basis-poin cu has susained credi growh of over 0.3 percenage poins higher hereafer. However, he erm spread reducion ypically has small and no saisically significan effecs on US oupu growh, and i lowers CPI inflaion and equiy prices iniially. I also raises he VIX by over 6 percen iniially, wih saisically significan effecs in he firs hree monhs afer he shock. This suggess ha a decline in he US erm spread may be perceived negaively by markes, for example as a harbinger of less encouraging prospecs. 26. Second, esimaes based on he corporae spread model sugges ha differen channels migh be a play. Lowering he erm spread has less impac on oupu, and over ime i depreciaes he US dollar. In conras, a 20.7-basis-poin reducion in he US corporae spread has a srong, posiive and saisically significan impac on US growh, elevaing real GDP growh by 0.2 percenage poins hroughou he hree-year horizon. A cu in he US corporae spread consisenly booss equiy price and CPI inflaion, bu i raises credi growh by less han 0.1 percenage poins, and i has lile impac on he exchange rae Consisen wih he findings in Blinder (2012), 14 i apparenly pays off o ake acions ha arge corporae borrowing coss raher han indirecly driving down such coss by purchasing Treasury securiies o lower long-erm sovereign yields. This corroboraes he earlier findings in he lieraure ha LSAP1 had a larger impac han laer asse purchases, 15 since he LSAP1 program included an imporan componen of privae asse purchases (i.e. agency deb and agency MBS) 11 Examples include Pesaran and Smih (2006) and Dees, di Mauro, Smih and Pesaran (2007), where he 90 percen boosrapped error bands around he mean esimaes of impulse responses are generally large and include zero. Chudik and Frazscher (2012) insead use he 25h and 75h perceniles as he range of heir error bands. 12 We compue boosrap confidence inervals wih 5000 ieraions and provide 90 percen boosrapped error bands for he median impulse response esimaes. 13 The persisen response of real GDP growh (and oher variables) o a erm- or corporae-spread shock may reflec our choice of no imposing money neuraliy while idenifying he moneary policy shock in our GVECM, where he real GDP growh is an I(1) process in mos economies. 14 Blinder (2012) argues ha his paricular brand of unconvenional moneary policy (purchases of privae-secor securiies o reduce risk premiums) appeared o work very well in he cases of CP and MBS. Bu, of course, he risk spreads were hen a crisis levels. One canno expec such srong effecs under more normal marke condiions. Tha said, every privae deb marke is less deep and less liquid han he Treasury markes. So i is reasonable o expec more ineres rae bang for each buck of asse purchases. 15 See, for example, Meaning and Zhu (2011) and Goodhar and Ashworh (2013).

12 11 Figure 1. Impulse Responses o US Term and Corporae Spread Shocks: Unied Saes 1,2 Real GDP growh CPI inflaion Growh of credi o privae secor Percenage poins Percenage poins Percenage poins VIX Equiy price Foreign exchange pressure 3 Per cen Per cen Per cen 1 The esimaes correspond o he crisis sample ranging from July 2007 o February The US erm spread shock is a one-sandard-deviaion (i.e basis poins) negaive innovaion o US erm spread, and he US corporae spread shock is a one-sandard-deviaion (i.e basis poins) negaive innovaion o US corporae spread. 3 A rise in he foreign exchange pressure index represens sronger appreciaion pressure. Source: Auhors calculaions based on an esimaed GVECM. C. Cross-Border Moneary Policy Spillovers 28. We sudy he cross-border impac of US QE measures using he weighed regional average impulse responses o a one-sandard-deviaion shock o US erm (14.2 basis poins) and corporae (20.7 basis poins) spreads for he oher major advanced economies, emerging Asia and Lain America. 16 Figure 2 presens, for each individual economy, he corresponding 16 The impulse responses in each region are presened as he weighed averages of he median impulse response esimaes of he regional economies, he weighs being heir real GDP shares in he region, based on each economy s average real GDP beween 1995 and The weighs are similar o hose calculaed for The averaging masks sizeable crosseconomy differences, and he averaged confidence bands are no longer valid for he average esimaes.

13 12 maximum impulse responses o a reducion in he US corporae spread; and Tukey boxplos in Figure 3 provide informaion on heir dispersion in each region. 29. Depending on wheher i is a erm or corporae spread shock, he non-us economies responses vary in erms of he size and direcion. The responses o a US corporae spread shock are ypically much larger. In paricular, a cu in he US corporae spread ends o promoe persisenly higher real GDP growh and inflaion in all hree regions, wih greaer impac in a number of Lain American and emerging Asian economies. This migh have resuled from sronger responses in equiy prices, i.e. he cross-border confidence channels may work beer when moneary policy measures focus on driving down he US corporae raher han he erm spread. In addiion, lowering he US corporae spread also leads o ypically larger exchange rae appreciaion pressure in Lain America and emerging Asia, implying a sronger exchange rae channel in he QE spillovers o he emerging economies. 30. The effecs of US QE measures have differed across economies and variables, wih subsanial cross-region differences in he impulse responses o he US spread shocks, noably in erms of moneary and exchange rae policies. This may indicae differen ransmission and adjusmen mechanisms in differen economies. While moneary policy loosens in he advanced economies in response o a US erm or corporae spread shock, he emerging economies respond o differen ypes of US easing in differen ways. Noably, besides Argenina, Malaysia and Singapore, moneary policy in mos emerging economies end o loosen in response o a cu in he US corporae or erm spread. More emerging economies end o loosen in response o a cu in he US corporae spread. Currencies in he advanced economies on average depreciae in response o a US erm spread shock. Bu appreciaion pressures end o rise in Lain America following a cu in he US erm or corporae spread, which urn ou o be larger. Bu some emerging Asian currencies end o depreciae while ohers end o appreciae. 31. The esimaed impulse responses for each economy generally confirm he resuls based on he regional averages, bu here are sizeable cross-economy differences. To illusrae his, we firs provide some measures of dispersion, e.g. he range and iner-quarile range, in he esimaed maximum impulse responses over a wo-year horizon for he 17 economies; we hen describe and differeniae he resuls for he euro area, Brazil and China, he larges economies from each of he hree groupings. 32. Figure 3 presens Tukey boxplos, which summarise he wihin-region crosseconomy dispersion in each variable s esimaed impulse responses; he responses are o a one-sandard-deviaion reducion in he US erm (14.2 basis poins) and corporae spread (20.7 basis poins). The boom and op of he boxes indicae he 25h and 75h perceniles of he maximum impulse response esimaes in each region, he boom and op whiskers represen he range of he esimaes, and he cross indicaes he median. 33. The maximum impulse response esimaes deliver generally similar messages. In boh cases, he wihin-region dispersion is sizeable and he esimaes differ boh in size and sign; in mos cases, he range of impulse response esimaes for he emerging economies includes zero. Moreover, he median esimaes, e.g. for he oupu growh, credi growh, equiy price and foreign exchange pressure, end o have he expeced sign, especially in he case of a reducion in he US corporae spread. For equiy prices, while he median esimaes are all

14 13 posiive in he case of a cu in he US corporae spread, he median responses o a reducion in he US erm spread are negaive. This is due o an iniial drop in he equiy prices which urned ou o be larger han heir laer persisen rise. 34. Comparing he hree regions, he esimaes in he non-us advanced economies ypically have a much smaller dispersion, possibly reflecing more similar economic srucures and a higher degree of economic and financial inegraion, as well as a smaller number of economies in he group (Figure 2). In conras, impulse response esimaes for he emerging economies end o have larger dispersions. Second, he dispersion is generally greaer for he esimaed impulse responses o a shock o he US corporae raher han erm spread, excep for equiy price and foreign exchange pressure. We focus our discussions on he impulse response esimaes for hree economies: he euro area, Brazil and China A US easing raises euro area inflaion. Following a 14.2-basis-poin cu in he US erm spread, he euro area erm spread falls significanly and says lower by over 10 basis poins during mos of he hree-year horizon. The almos one-o-one response shows a igh relaionship beween he wo economies. A 20.7-basis-poin cu in he US corporae spread also lowers he euro area erm spread. I drives up euro area credi and oupu growh by abou 0.1 and 0.2 percenage poins, respecively. Euro area equiy price inflaion rises by over 1 percenage poin in four monhs. Reducing he US corporae spread depreciaes he euro by abou 0.5 percenage poins, bu lowering he US erm spread has lile effecs on he euro exchange rae. 36. In Brazil, while money growh rises in response o a US erm spread shock, i falls in response o a US corporae spread shock. The Brazilian equiy price rises slighly and hen says almos unchanged afer an iniial decline of up o 2.4 percen upon a US erm spread shock, bu i rises consisenly a 1.2 percen or more four monhs afer a cu in he US corporae spread. Credi and oupu growh generally accelerae and currency appreciaion pressure rises following a US easing, wih a sronger evenual impac from he US corporae spread shock. 17 The impulse response esimaes for all 17 economies, wih he respecive confidence bands, are available upon reques. They end o be large in many cases, bu ofen no significanly differen from zero due o he esimaion difficulies wih large-scale GVECMs and he small crisis sample.

15 14 Figure 2. Maximum Impulse Responses o a US Corporae Spread Shock 1 Real GDP growh Percenage poins CPI inflaion Percenage poins Credi growh o he privae secor Moneary policy indicaor 2 Percenage poins Percenage poins Equiy price Foreign exchange pressure 3 Per cen Per cen AR = Argenina; BR = Brazil; CL = Chile; CN = China; GB = Unied Kingdom; HK = Hong Kong SAR; ID = Indonesia; IN = India; JP = Japan; KR = Korea; MX = Mexico; MY = Malaysia; PH = Philippines; SG = Singapore; TH = Thailand; US = Unied Saes; XM = Euro area. 1 The US corporae spread shock is a one-sandard-deviaion (i.e basis poins) negaive innovaion o he corporae spread. 2 For moneary policy indicaors, we use corporae or erm spreads for he advanced economies, and growh raes of a broad moneary aggregae for emerging economies. 3 A rise in he foreign exchange pressure index represens sronger appreciaion pressure. Source: Auhors calculaions based on an esimaed GVECM.

16 15 Figure 3. Disribuion of Maximum Impulse Responses o US Term and Corporae Spread Shocks 1,2 Real GDP growh CPI inflaion Credi o he privae secor growh Percenage poins Percenage poins Percenage poins Moneary policy indicaor 6 Equiy price Foreign exchange pressure 7 Percenage poins Per cen Per cen 1 The US erm spread shock is a one-sandard-deviaion (i.e basis poins) negaive innovaion o he US erm spread, and he US corporae spread shock is a one-sandard-deviaion (i.e basis poins) negaive innovaion o he US corporae spread. 2 In he Tukey boxplos he boom and op of he boxes are he firs and hird quariles of he cumulaive impulse responses of he region; he cross indicaes he median; and he boom and op whiskers represen he range of he responses. 3 Euro area, Japan and he Unied Kingdom. 4 China, Hong Kong SAR, India, Indonesia, Korea, Malaysia, he Philippines, Singapore and Thailand. 5 Argenina, Brazil, Chile and Mexico. 6 For moneary policy indicaors, we use erm and corporae spreads for he advanced economies, and he growh raes of a broad moneary aggregae for he emerging economies. 7 A rise in he foreign exchange pressure index represens sronger appreciaion pressure. Source: Auhors calculaions based on an esimaed GVECM. 37. China s esimaed policy responses o US simulus differ depending on he naure of he US shock. Following a cu in he US erm spread, China s money and credi growh raes drop by 0.2 and 0.3 percenage poins in he second monh afer he shock, hey hen urn slighly posiive in a few monhs before a persisen decline. In response o a drop in he US corporae spread, however, he money and credi growh raes rise modesly for abou six monhs before falling persisenly hereafer. For boh shocks, he Chinese yuan faces persisen depreciaion pressures due o is close associaion wih he US dollar, bu he pressure is greaer during he firs 20 monhs following a cu in he US corporae spread, being significan and reaching 0.23 percenage poins in one monh.

17 The evidence suggess ha reducing he US corporae spread is more accommodaive overall for he Chinese economy, even hough China ends o lean agains i wih moneary and credi policies. Real GDP growh increases significanly and rapidly by 0.13 percenage poins following a 20.7-basis-poin cu in he US corporae spread, despie an iniial drop, and evenually, inflaion rises persisenly by abou 0.16 percenage poins. The oupu response o a US erm spread shock is smaller, and he inflaion response is mosly negaive. Equiy price rises following a US corporae spread shock, and i generally falls afer a US erm spread shock. 39. One ineresing finding is ha US QE measures urn ou o have a greaer impac on economic and financial variables in many emerging economies han on he US economy. This is consisen wih previous work. For example, Mackowiak (2007) finds ha US moneary policy shocks in he pre-crisis period quickly and srongly affec ineres and exchange raes in a ypical emerging economy, and price and real oupu here respond more han he US counerpars. This evidence suppors he view ha cross-border moneary policy spillovers canno be dismissed as insignifican by-producs of lile consequence for he global economy. As Rajan (2013) pus i, even if he unconvenional moneary policies ha focus on lowering ineres raes across he erm srucure have limied effecs on ineres raes in he large, liquid, sending counry Treasury markes, he volume of flows hey generae could swamp he more illiquid receiving counry markes, hus creaing large price and volume effecs. Robusness check 40. The resuls of impulse response analyses are robus o differen model specificaions and variable definiions, including he use of base money growh insead of broad money growh, he use of he federal funds rae insead of he hree-monh US Treasury bill rae o calculae he US erm spread, and he use of he hree-monh US Treasury bill rae insead of he federal funds rae o calculae he US corporae spread. The resuls are also robus o alernaive orderings of he variables in he idenificaion scheme for he shocks o he US erm and corporae spreads. III. GVECM-BASED COUNTERFACTUAL ANALYSIS 41. We conduc counerfacual analyses o evaluae he domesic and global impac of US QE measures. We consruc wo counerfacual scenarios based on US corporae spread developmens. 18 We hen make condiional forecass for model variables based on he assumpion ha he US corporae spread follows a predeermined counerfacual pah. By comparing hese projecions o he acual daa, we can assess he overall impac on he global 18 We presen he resuls for he counerfacual analysis based on US corporae spread developmens, given ha heir economic effecs are larger. Deails on he counerfacual analysis based on US erm spread developmens can be provided upon reques.

18 17 economy of he US QE measures, and he separae impacs of he LSAP1, LSAP2, MEP and LSAP3 programs The counerfacual analysis is based on he esimaed GVECM model and one-sepahead projecions. Specifically, equaion (8) in Appendix A illusraes how an endogenous variable can be expressed as he sum of he lagged explanaory variables (boh domesic and foreign) muliplied by he corresponding parameer esimaes, plus he esimaed residuals. Given he values of all model variables up o ime, and condiional on he ime- counerfacual value of he corporae spread, we obain he one-sep-ahead forecass for he endogenous variables ( ). In he nex sep, we use he forecass and he ime +1 counerfacual value of he corporae spread o obain he ime +2 forecass ( ), and so on. The forecass of each endogenous variable herefore depend on he pas forecass of he oher variables and he specified US moneary policy pah. 43. We design wo differen counerfacual scenarios: Consan scenario: we assume ha he US corporae spread remains consan wihin each period of he QE program, a he level seen immediaely before he implemenaion of each US asse purchase program, namely LSAP1, LSAP2, MEP and LSAP3; 2. Jump scenario: we assume he US corporae spread jumps by 200 basis poins a he sar of each QE program, hereafer i says above he acual values during he enire program. 44. Figure 4 shows boh he acual and he wo counerfacual pahs for he US corporae spread. 45. Our counerfacual analyses sugges ha US QE measures had sizeable domesic effecs, and such effecs varied subsanially depending on wheher he measures led o a subsanial fall in he US corporae spread. In cases where he Federal Reserve asse purchases kep he US corporae spread a a low level relaive o he baseline, such acions appeared o have conribued o sronger US economic recovery. 19 In doing his exercise, we need o bear in mind ha he acual daa could also reflec many oher facors affecing he global economy; hese may include supply-side shocks such as euro area sovereign deb crisis, large fiscal simulus in China, and commodiy price flucuaions. 20 We also examine an increasing scenario, in which he US corporae spread is assumed o rise by 10 basis poins, in each and every monh during each QE program. As he resuls are similar, we only presen he resuls associaed wih he consan and jump scenarios.

19 18 Figure 4. Counerfacual Analysis of Domesic US QE Impac: US Corporae Spread 1 Real GDP growh CPI inflaion Credi growh o he privae secor Percenage poins Percenage poins Percenage poins Corporae spread Equiy price Foreign exchange pressure 2 Percenage poins Naural logarihm Per cen 1 The grey areas indicae he periods of implemenaion of LSAP1, LSAP2 and MEP. The black lines are acual values. The red lines are he values associaed wih he jump scenario where he US corporae spread jumps by 200 basis poins and says 200 basis poins above he acual levels hroughou he respecive QE program, and he blue lines depic he scenario where he US corporae spread says equal o he acual level observed jus before he QE program. 2 A rise in he foreign exchange pressure index represens sronger appreciaion pressure. Source: Auhors calculaions based on an esimaed GVECM. 46. Figure 4 presens he dynamics of US economic and financial variables under he consan and jump scenarios for he US corporae spread. 21 The counerfacual exercise, a face value, indicae ha wihou QE, especially he purchases of agency MBS and agency deb which helped o lower he US corporae spread, he US economy would have remained mired in a recession wih deflaion. The jump scenario suggess ha asse purchases may have suppored higher real GDP growh by abou 8 percenage poins, and inflaion by over 21 Noice ha during LSAP1, he US corporae spread acually drifed back up midway hrough he program o levels higher han when LSAP1 began, and hen kep climbing during LSAP2 (Figure 4). This can be inerpreed o sugges ha he LSAP1 and LSAP2 programs had a ransiory impac on he US corporae spread, and would raise quesions abou wheher he consan scenarios are ruly sress scenarios. Anoher possible explanaion is ha oher facors such as adverse supply shocks or furher financial secor srains could have dilued he effecs of he asse purchases and pushed he US corporae spread higher han oherwise.

20 19 5 percenage poins. Equiy prices would have been much lower wihou he QE measures. The consan scenario indicaes even greaer effecs. In addiion, while he jump scenario poins o appreciaion pressures on he US dollar during much of he implemenaion of each program, cumulaively he programs exered sizeable depreciaion pressures. Moreover, he counerfacual exercise indicaes ha he programs acually slowed credi growh. 47. In sum, he counerfacual exercises sugges ha he domesic effecs of differen US QE measures were diverse. In he model, QE programs which reduced he US corporae spread delivered a sizeable simulus o US oupu growh and equiy markes and led o subsanial currency depreciaion. If he counerfacual exercise is seen as a reasonable approximaion o wha would have happened, he findings sugges ha QE programs helped o preven he US economy from sliding ino a prolonged recession wih severe deflaion. The resuls sugges ha if policymakers aim o lower privae-secor borrowing coss and simulae growh, i pays o design programms o influence he corporae spread. A. Spillovers from Reducions in he US Corporae Spread 48. The resuls in his secion show ha he cross-border spillover effecs from US QE policies ha reduce he US corporae spread are sizeable. We presen he resuls on he euro area, Brazil and China. 49. In he counerfacual analysis, US unconvenional policies are esimaed o have had an imporan impac on he euro area (Graph 3.2.1): he lower US corporae spread is esimaed o have suppored euro area credi and oupu growh, wih he impac ranging from 3 and 8 percenage poins (jump scenario) o 7 and 16 percenage poins (consan scenario), respecively, significanly boosing equiy prices. 50. The analysis also suggess ha US QE measures had even greaer spillover effecs on he emerging economies, again much hrough he reducion in he US corporae spread. The esimaed impac ended o be diverse across economies and across variables, which may reflec diverse policy responses, exchange rae regimes and economic srucures. 51. The evidence from he counerfacual exercise also suggess ha lowering he US corporae spread simulaed Brazil s oupu growh while having lile impac on inflaion. Arguably, his evidence suggess ha LSAP1 helped he Brazilian economy recover rapidly from he 2009 recession, and ha MEP and LSAP3 migh have helped Brazil avoid a possible recession in Bu LSAP2 began when Brazil s oupu growh reached a peak of almos 8 percen, and herefore migh be inerpreed as having conribued o Brazil s overheaing a he ime. These Brazilian episodes highligh ha he percepion of moneary policy spillovers may be influenced by he receiving counry s cyclical posiion.

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