The current synchronous tightening cycle
The current global monetary tightening cycle turned out to be the most synchronized one in the past half-century, argue Moessner et al. in this commentary. By February 2023, more than 90% of economies had hiked their policy rates. Historically, this share has rarely exceeded 50%, reaching 70% only during the oil price shocks of the 1970s. The pace of tightening was also remarkably fast in EMEs where central banks have raised nominal policy rates at about twice their historical pace. This degree of synchronicity in monetary policy tightening makes it more difficult for individual central banks, including the ECB, to calibrate their own monetary policy as it becomes difficult to estimate the strength of cross-country monetary policy spillovers. The magnitude of these spillovers is quite uncertain so the risk is for central banks to implement an excessively tighter monetary policy. There are three overlapping channels through which spillovers manifest themselves: a) the aggregate demand channel; b) the exchange rate channel; and c) the financial channel. The latter two tend to be larger and more contractionary for activity when monetary tightening takes place in the United States.
An appreciation of the US dollar tends to drive up energy and food consumer price inflation in local currency. Moreover, energy and food consumer price inflation are generally salient for consumers’ decisions and therefore affect household expectations of inflation strongly. This is particularly important for the euro area where the ECB, the authors argue, can affect euro area inflation by affecting domestic and global energy prices with monetary policy via the effect of policy rate changes on the euro-dollar exchange rate.
Global Inflation and Global Monetary Policy Tightening: Implications for the Euro Area
By: Richhild Moessner, Dora Xia, Fabrizio Zampolli – BIS
The impact of synchronous monetary tightening
Caldara et al., in this paper, find that episodes of global tightening are associated with larger economic downturns, worse financial conditions, and a relatively muted decline in inflation. They develop a model where the amplification of synchronous tightening works through its effects on the balance sheets of global financial intermediaries that face occasionally binding leverage constraints. More specifically, central to their model is the presence of leveraged global financial intermediaries (GFIs) that raise funds both domestically and abroad. The authors assume that GFIs’ ability to intermediate assets depends on their net worth: when net worth is high, global intermediaries absorb losses by raising more debt, guaranteeing the smooth functioning of international credit markets. When net worth is low, for instance, due to a decline in asset prices caused by higher interest rates, financial intermediaries are limited in their ability to issue new debt and are forced to sell assets. The resulting financial constraints, in this model, act primarily to restrict demand for investment. This mechanism leads to a nonlinear financial amplification of global tightening episodes which impacts output much more than inflation, thus worsening monetary policy trade-offs. In terms of policy recommendation, Caldara et al. argue that:
- When global inflationary shocks are small, credit spreads do not rise, financial spillovers are muted, and the model predicts that the optimal monetary policy from an individual country’s perspective remains nearly optimal from a global perspective.
- When the inflationary shocks are large enough, financial frictions become active, credit spreads rise, and macroeconomic spillovers become large. When this happens, strategic considerations become relevant for the conduct of monetary policy.
The International Spillovers of Synchronous Monetary Tightening
Authors: Dario Caldara, Francesco Ferrante, Matteo Iacoviello, Andrea Prestipino, and Albert Queralto
From: Federal Reserve Board
