The Transmission of Euro Area Interest Rate Shocks to Asia -- Do Effects Differ When Nominal Interest Rates are Negative?

ABSTRACT

This paper proposes a non-linear factor-augmented vector autoregressive model to evaluate spillovers to Asia from an unexpected rate cut in the euro area. We focus on potential asymmetries in the transmission of the shock that could arise due to prevailing negative interest rates in the euro area. Our findings indicate significant and negative effects on short-and long-term interest rates throughout selected Asian economies. While the cross-country impact on yields is quite homogeneous when the policy rate in the euro area is positive, large heterogeneity emerges when the shock occurs under a negative interest rate environment in the euro area. For several countries, the effects on Asian long-term yields are stronger, this implies that not only relative yield differentials play a role for international investors but also the absolute yield level. In this sense, negative interest rate policies can act as an amplifier of international portfolio rebalancing.

KEYWORDS:

• NIRP
• yield curve
• capital flow
• emerging Asia
• FAVAR

JEL:

• C3
• E3
• E5

Notes

1. Punzi and Chantapacdepong (2017) found that central banks in the Asia and Pacific region have accommodated their monetary policy in response to unconventional monetary policy measures in advanced economies. More specifically, this has led to lower interest rates, currency appreciation, and asset price boom associated with strong capital flows in the region.

2. For simplicity, we omit deterministic terms in the description of the model. In the empirical application we include a constant.

3. The data we use in the empirical application is transformed to be approximately stationary. This implies that we set δ = 0 in what follows.

4. The wider credible set stem from the fact that this regime is characterize by fewer observations and thus more estimation uncertainty.