On the global Impact of risk-off shocks and policy-put frameworks

BIS Working Papers  |  No 772  | 
08 March 2019



Big sell-offs in financial markets ("risk-off shocks") can trigger severe recessions if fiscal and monetary policymakers fail to respond appropriately. After the Great Financial Crisis (GFC), central banks in advanced economies resorted to unconventional monetary tools such as asset purchases. These measures successfully propped up the economy, but they have also been criticised for encouraging investors to buy riskier assets ("reach-for-yield behaviour"). As such, they have been seen as a sort of free "put option" or insurance policy for investors.


We look at how financial markets around the world have reacted to risk-off shocks, and how the authorities have responded. First, we focus on how risk-off shocks have affected the financial markets of advanced economies, comparing their effects before and after the GFC. We then study the knock-on effects ("spillovers") from these shocks to emerging market economies (EMEs). We explore how these effects were influenced by the monetary policy of advanced economies, as well as the economic condition of EMEs. We pay particular attention to how the response of EMEs to these shocks has changed since the GFC.


We find that the unconventional monetary policies of the main advanced economies were highly effective, at a time when already low interest rates would have hindered central banks from attempting to boost the economy through further policy rate cuts. Without these policies, financial markets would have been more vulnerable to global sell-offs. Most of the policy discussion has focused on the problems arising from the strong capital flows into EMEs that these policies encouraged. But we document a positive side to these policies. They increased the resilience of the rest of the world against global risk-off shocks. For EMEs in particular, this took the form of smaller credit spreads and a reduced tendency for long-term interest rates to rise sharply following such shocks.



Global risk-off shocks can be highly destabilizing for financial markets and, absent an adequate policy response, may trigger severe recessions. Policy responses were more complex for developed economies with very low interest rates after the GFC. We document, however, that the unconventional policies adopted by the main central banks were effective in containing asset price declines. These policies impacted long rates and inspired confidence in a policy-put framework that reduced the persistence of risk-off shocks. We also show that domestic macroeconomic and financial conditions play a key role in benefiting from the spillovers of these policies during risk-off episodes. Countries like Japan, which already had very low long rates, benefited less. However, Japan still benefited from the reduced persistence of risk-off shocks. In contrast, since one of the main channels through which emerging markets are historically affected by global risk-off shocks is through a sharp rise in long rates, the unconventional monetary policy phase has been relatively benign to emerging markets during these episodes, especially for those economies with solid macroeconomic fundamentals and deep domestic financial markets. We also show that unconventional monetary policy in the US had strong effects on long interest rates in most economies in the Asia-Pacific region (which helps during risk-off events but may be destabilizing otherwise -we do not take a stand on this tradeoff).

JEL classification: E40, E44, E52, E58, F30, F41, F44, G01

Keywords: Risk-off, conventional and unconventional monetary policy, policy-puts, spillovers, macroeconomic fundamentals, developed and emerging markets, Asia-Pacific region.