“It is evident from the impulse responses that the domestic economy faces an immediate decline in output due to a contractionary US monetary policy shock,” they said.
The decrease in output may be accompanied by a rise in domestic inflation, albeit, not significantly.
Both Goldman Sachs and Bank of America predicted the US Federal Reserve to raise interest rates three more times in 2023. The Fed had already raised its policy rate eight times totaling 450 basis points since March 2022,
In its last monetary policy, RBI projected the GDP growth at 7% for FY23 and 6.4% for FY23. The central bank expected inflation to be at 6.5% for FY23, higher than its upper tolerance band of 6%. The International Monetary Fund projected global growth at 2.9% in 2023 and 3.1% in 2024.
Financial markets in India are now closely linked with the global financial system. For example, during the “taper tantrum” episode, when the Fed reduced its bond purchases in 2013, India witnessed fluctuations in capital flows, excessive exchange rate pressures, financial market volatility and slowdown in GDP growth, cross-border trade, and domestic investments.
The data also suggests that a contractionary US monetary policy shock leads to a rise in global risk aversion, which in turn causes domestic equity prices to fall alongside a depreciation of the domestic currency. The researchers argued that US monetary policy spillovers to emerging market economies, especially those from unconventional policies, have been primarily driven by the financial channel.
“This channel captures the tightening of long-term interest rates in the US that accompanies policy tightening by the US Fed. Higher long-term yields allows global investors to switch from foreign assets to US assets, thereby hardening foreign financial conditions followed by a reduction in GDP and inflation in EMEs,” said Bhanu Pratap and Thangzason Sonna of RBI’s department of economic and policy research.
The RBI maintains that the views expressed in the research paper are of the researchers and do not represent its official view.
Interestingly, in the case of the post-2008 sample, it was found that US monetary policy shocks cause a dip in domestic economic activity as well as domestic inflation. “The fall in output growth and inflation is statistically significant and persistent, with output growth and inflation continuing to decrease for more than four quarters,” the paper said.