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Did capital market convergence lower the effectiveness of monetary policy?

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  • Pieter Jansen

Abstract

International capital market convergence reduces the ability for monetary authorities to set domestic monetary conditions. Traditionally, monetary policy transmission is channelled through the short-term interest rate. Savings and investment decisions are effected through the response of the bond yield to changes in the short-term interest rate. We find that capital market integration increased correlation between long-term interest rates across countries. Short-term interest rates also show more integration across countries and the correlation with the international business cycle has increased. A stronger linkage between international economic conditions and bond yields has important implications for the effectiveness of monetary policy. Monetary policy makers, especially in small countries, will face more difficulties in influencing domestic conditions in the bond market when they apply the traditional monetary policy framework in case of a country specific shock.

Suggested Citation

  • Pieter Jansen, 2009. "Did capital market convergence lower the effectiveness of monetary policy?," Applied Financial Economics, Taylor & Francis Journals, vol. 19(12), pages 975-984.
    • Handle: RePEc:taf:apfiec:v:19:y:2009:i:12:p:975-984
    DOI: 10.1080/09603100802359992
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    References listed on IDEAS

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    1. Fell, J.P.C., 1996. "The Role of Short Rates and Foreign Long Rates in the Determination of Long-Term Interest Rates," Papers 4, European Monetary Institute.
    2. Shu Wu, 2008. "Monetary Policy And Long‐Term Interest Rates," Contemporary Economic Policy, Western Economic Association International, vol. 26(3), pages 398-408, July.
    3. Pierdzioch, Christian, 2003. "Home-Product Bias, Capital Mobility, and the Effects of Monetary Policy Shocks in Open Economies," Kiel Working Papers 1141, Kiel Institute for the World Economy (IfW Kiel).
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