Various central bankers in emerging market economies have expressed concerns regarding the international spillovers of the U.S. and European quantitative easing, arguing for more coordinated global monetary policies. Despite the increasing interest in the topic, isolating the effect that the monetary policy of a country has on another country’s economy is not trivial, since many confounding factors (such as trade relations between countries or global macroeconomic shocks) take place simultaneously.
In this paper, we analyze how foreign monetary policy impacts the local economy through the bank lending channel. We focus on Mexico, a country that provides an excellent empirical setting for identification given the exhaustive micro data sets (information from the credit registry matched to firm and bank level data) and the important presence of foreign banks. [1] Our data set contains all corporate bank loans in Mexico matched with firm and bank balance-sheet information. The data set, which starts in January 2002, includes all new and outstanding commercial loans at a monthly frequency, as well as the relevant loan terms, including loan rates (that are absent in most credit registers around the world). To identify the international credit channel, we study monetary policy shocks over a 10 year period- both in the form of interest rates and non-standard quantitative easing- from three different regions: the U.S., the U.K, and the Euro Area. Importantly, these regions correspond to the headquarters of the main banks in Mexico. Furthermore, and different from papers that analyze local monetary policy on local credit conditions, we examine European (Eurozone and UK) and US monetary policies, which are largely determined exogenously to the Mexican economy. [2]
In particular, we examine whether international monetary policy affects: i) the supply of credit from foreign banks to Mexican firms and ii) the risk-taking of foreign banks. We further explore whether the international monetary policy shocks that are passed to firms through the “bank-lending channel” have real effects on Mexican firms. In principle, local firms could neutralize international shocks by substituting bank credit of foreign banks with other sources of finance.
Controlling for changes in credit demand is one of the main challenges when identifying the effect of international monetary policy on bank credit supply. When the monetary policy of a country changes, certain firms (such as firms with trade relations with that country) may have different borrowing reactions. If we only consider changes in firms’ credit outcomes, without controlling for demand, we may overestimate the role that foreign monetary policy shocks have on the way banks respond. One way we overcome this challenge is by comparing the loans offered to the same firm in a given month by different foreign banks, which are exposed to different monetary policies. To understand whether banks engage in reach-for-yield under more accommodative monetary policies, we compare the variation in credit supplied to borrowers depending on their ex-ante loan rates. Finally, and given that our data includes balance-sheet information of firms, we examine if firms substitute foreign credit suppliers with credit from other banks or from other sources.
Our results suggest that a softening of foreign monetary policy increases the supply of credit of foreign banks to Mexican firms. Each regional policy shock affects supply via their respective foreign banks. For instance, U.S., U.K. and Eurozone monetary policy affect credit supply to Mexican firms via U.S., U.K. and Eurozone banks in Mexico, respectively. All loan terms are affected, but effects are substantially weaker for loan rates. Moreover, the international monetary policy channel implies strong real effects, with substantial stronger elasticities from monetary rates than QE. Finally, a decline in foreign monetary policy rates and an expansion in QE lead to higher credit supply for borrowers with higher ex-ante loan rates (reach-for-yield), with substantial higher ex-post loan defaults, thus suggesting an international risk-taking channel of monetary policy. Furthermore, foreign QE is found to affect more risk-taking in emerging markets through an expansion of credit supply to riskier firms rather than improving real outcomes of firms in emerging markets.
The results are consistent with, among others, claims by Governor Rajan of the Reserve Bank of India (2014) and the Jackson Hole speech by Rey (2013), and thus suggest the need for a more coordinated global monetary policy, for example at the G-20 level with both high income and emerging countries. An important avenue for future research is whether local macroprudential policies (Freixas, Laeven and Peydró (2015)) can reduce, or even neutralize, the foreign externalities stemming on emerging markets from foreign monetary policy from core economic areas, or whether a more coordinated global monetary policy is the only solution.
References
Freixas, Xavier, Luc Laeven, and José-Luis Peydró, 2015, Systemic Risk, Crises and Macroprudential Policy. MIT Press.
Rajan, R. (2014). “Competitive Monetary Easing: Is It Yesterday Once More?” Speech at the Brookings Institution, April 10, 2014.
Rey, H. (2013): “Dilemma Not Trilemma: The Global Financial Cycle and Monetary Policy Independence,” paper presented at “Global Dimensions of Unconventional Monetary Policy,” Jackson Hole, Federal Reserve Bank, August 22-24.
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