What explains international interest rate co-movement?

Abstract

This paper decomposes international interest rate co-movement into contributions of domestic, foreign, and global supply, demand, and monetary policy shocks across seven advanced economies. We develop a Bayesian structural panel vector autoregression, integrating informative priors and homogeneity restrictions on contemporaneous relations, a hierarchical Minnesota prior with cross-sectional shrinkage, and a factor structure for structural shocks. We show that interest rate co-movements are driven by monetary policy responses to synchronized business cycle fluctuations, caused by demand shocks. In the short run, domestic shocks dominate interest rate variation. Cross-country spillovers arise gradually over time and have a smaller impact in larger economies.

Publication
Conditional accept at the Journal of Applied Econometrics