Monetary policy and financial spillovers: losing traction?

BIS Working Papers No 518
October 2015

Published in: Journal of International Money and Finance, vol 74, June 2017, pp 115-136.

Has financial globalisation compromised central banks' ability to manage domestic financial conditions? This paper tackles this question by studying the dynamics of bond yields encompassing 31 advanced and emerging market economies. To gauge the extent to which external financial conditions complicate the conduct of monetary policy, we isolate a "contagion" component by focusing on comovements in measures of bond return risk premia that are unrelated to economic fundamentals. Our contagion measure is designed to more accurately capture spillovers driven by exogenous global shifts in risk preference or appetite. The analysis reaches several conclusions that run counter to popular presumptions based on comovements in bond yields. In particular, emerging market economies appear to be much less susceptible to global contagion than advanced economies, and the overall sensitivities to contagion have not increased post-crisis.

JEL classification: E40, E43, E44, E50, E52, F30, F41, G15

Keywords: Monetary policy, financial spillovers, contagion, interest rates, trilemma, bond risk premium, capital flows