Did capital market convergence lower the effectiveness of the interest rate as a monetary policy tool?

Pieter W. Jansen
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Pieter W. Jansen: Vrije Universiteit Amsterdam, Faculteit der Economische Wetenschappen en Econometrie (Free University Amsterdam, Faculty of Economics Sciences, Business Administration and Economitrics

No 10, Serie Research Memoranda from VU University Amsterdam, Faculty of Economics, Business Administration and Econometrics

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.

Keywords: Monetary policy; Term structure of interest rates; International capital market convergence (search for similar items in EconPapers)
JEL-codes: E43 (search for similar items in EconPapers)
Date: 2006
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