A study by International Monetary Fund (IMF) economists Luc Laeven and Hui Tong found that U.S. monetary policies shocks drive global stock market prices.
When the Federal Reserve unexpectedly tightens (loosens) monetary policy, global equities tend to decline (rally), according to the study, which estimated that the unexpected component of U.S. interest movements has a negative coefficient of 0.04 with global stock prices.
For example, a 25-basis point increase of U.S. interest rates would reduce global stock prices by 1 percent. Interestingly, the impact of a 25-basis point rate hike on U.S. stock performance is similar.
The study also discovered that companies that depend on external financing and countries that are more integrated with the global financial market are more affected by U.S. monetary policy. The influence is also more pronounced during economic recessions.
These findings suggest that financial frictions play an important role in the transmission of monetary policy, and that U.S. monetary policy influences global capital allocation, said Laeven and Tong.
The study tracked more than 20,000 stocks across 44 countries from 1990 to 2008.
The findings has relevant implications to one of today's most hotly-debated topics in global economics, namely the Federal Reserve's loose monetary policy and second round of quantitative easing (QE2).
Critics argue that through its easy monetary policy, the Federal Reserve is stoking inflation and driving up asset prices in emerging market countries, which destabilizes those economies and sets them up for future crises.
Furthermore, the Federal Reserve is also blamed for partially causing to the subprime mortgage crisis by keeping interest rates too low in the 2000s. By the same logic, the Fed may also be building the next crisis by its current ultra-loose monetary policy.
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