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IF-2: Monetary Policy and Currencies
International Real Yields
I study market-implied real yields extracted from data on inflation-linked government bonds for 9 developed countries. The liquidity premium is an important component of inflation-linked bond yields, especially for short maturities and during the Great Recession, and explains a substantial part of the breakeven inflation rates. Low nominal yields following the Great Recession are mainly due to the decreasing real yields, although the inflation risk premium has also decreased in 5 out of 9 countries. The magnitude of the inflation risk premium varies by country but in most countries the inflation risk premium is on average smaller or equal to the inflation-linked bonds liquidity premium. Unconditional real yield curves, both adjusted and non-adjusted for liquidity, are upward sloping for short maturities and become flat for long maturities. The positive real term structure mostly accounts for the positive slope of the nominal term structure, although at the longer maturities the positive term structure of the inflation risk premium also plays an important role in some countries. Unconditionally, real and nominal yield curve slopes are highly correlated in most countries, but conditional correlations are lower during and shortly after the Great Recession.
U.S. Monetary Policy Transmission and Liquidity Risk Premia Around the World
1Cornell University; 2Seoul National University; 3Erasmus University Rotterdam
We examine how U.S. monetary policy changes affect liquidity risk premia on 43 stock markets around the world. Liquidity risk premia vary considerably over time and strongly co-move across countries. We find that they are significantly lower when U.S. monetary policy tightens. In particular, a positive shock to the Federal Funds futures rate of 10 basis points is associated with an average decline in the liquidity risk premium of 41 basis points. This effect is concentrated among higher liquidity risk stocks and is more acute when the foreign claims by U.S. banks on the country of interest are unusually high. Overall, our results indicate that U.S. monetary policy shocks affect the pricing of liquidity risk around the world and highlight the importance of the "bank channel" in the transmission of these shocks.
1Federal Reserve Bank of San Francisco; 2University of Chicago
We propose a novel, risk-based transmission mechanism for the effects of currency manipulation: policies that systematically induce a country's currency to appreciate in bad times, lower its risk premium in international markets and, as a result, lower the country's risk-free interest rate and increase domestic capital accumulation and wages. Currency manipulations by large countries also have external effects on foreign interest rates and capital accumulation. Applying this logic to policies that lower the variance of the bilateral exchange rate relative to some target country ("currency stabilization"), we find that a small economy stabilizing its exchange rate relative to a large economy increases domestic capital accumulation and wages. The size of this effect increases with the size of the target economy, offering a potential explanation why the vast majority of currency stabilizations in the data are to the U.S. dollar, the currency of the largest economy in the world. A large economy (such as China) stabilizing its exchange rate relative to a larger economy (such as the U.S.) diverts capital accumulation from the target country to itself, increasing domestic wages, while decreasing wages in the target country.
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Conference: EFA 2017
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