Monetary policy and financial spillovers: Losing traction?

Has financial globalisation compromised central banks’ effectiveness in managing domestic financial conditions? This paper tackles this question by studying the dynamics of bond yields encompassing 31 advanced and emerging market economies. To gauge the extent to which external financial conditions complicate the conduct of monetary policy, we isolate a “contagion” component by focusing on comovements in measures of bond return risk premia that are unrelated to domestic economic fundamentals. Our contagion measure is designed to more accurately capture, relative to simple yield correlation, spillovers driven by exogenous global shifts in risk preference or appetite. In contrast to what simple comovements in bond yields suggest, emerging market economies appear to be much less susceptible to global contagion than advanced economies and the overall sensitivities to contagion have not increased after the global financial crisis. The extent to which financial spillovers have compromised policy traction thus appears to be lower relative to studies based on common variation in bond yields.