We study spillover of monetary policy uncertainty shock from the US to other economies with different exchange rate regimes. A surge of monetary policy uncertainty in the US incurs contractionary consequences in other economies and decreases output, consumption, and stock market prices. Such effect is prevalent in fixed exchange rate regimes while flexible exchange rate regimes do not undergo the economic downturn. This is coupled with elevated uncertainty in fixed exchange rate regimes, while floating exchange rate regimes do not exhibit any change in uncertainty. We attribute this to the nature of flexible exchange rate regime and interpret that monetary autonomy in flexible regimes prevents direct spillover of foreign uncertainty shocks, especially those associated with interest rates. Unlike previous studies which point out the shock-absorbing role of flexible exchange rates via exchange rate depreciation, which we call the “exchange rate channel,” we focus on how monetary autonomy of flexible rate regime shuts down the transmission of monetary policy uncertainty from the US to local economy, the “uncertainty channel.” We show that shutting down the “uncertainty channel” dominates the “exchange rate channel” in flexible exchange rate regimes in terms of mitigating the spillover effects of foreign uncertainty shock.

We examine three main channels through which U.S. monetary policy shocks affect firm investment in foreign countries: (1) the balance sheet channel; (2) the financial channel of the exchange rate; and (3) the trade channel. For this purpose, we use quarterly firm-level data for 63 advanced economies (AEs) and emerging market and developing economies (EMDEs) over 1996-2016. Our results suggest an important and independent role for all three key channels. U.S. monetary policy shocks have larger effects on investment for firms that are more leveraged (balance sheet channel), for firms that have a higher share of debt in foreign currency (financial channel of the exchange rate), and for firms that operate in sectors with higher export dependence (trade channel). Back-of-the-envelope calculations suggest that the balance sheet channel is the most important channel of transmission of U.S. monetary policy shocks on aggregate firm investment.

investigate the global spillover effects of US monetary policy uncertainty in these three essays. In the first chapter, I focus on the impact of uncertainty on the macroeconomic activity of other advanced and emerging economies. I find that an increase in US monetary policy uncertainty reduces output, investment, consumption, exports, and imports in these economies. Such adverse effects are larger in relatively open than closed economies in trade and capital flows. Central banks around the world respond to heightened uncertainty by cutting policy rates, which is further validated by the evidence from central bank minutes. In the second chapter, I examine asset price spillovers from US monetary policy uncertainty to global asset prices. An increase in US monetary policy uncertainty raises sovereign yields and depreciates exchange rates in advanced and emerging economies. A higher level of uncertainty weakens the global transmission of US monetary policy to asset prices. Spillovers from uncertainty to asset prices are larger for the countries with high trade integration, but such effects on sovereign yields are larger only in advanced economies with higher financial integration and the exchange rate peg than the flexible regime. The third chapter investigates how uncertainty about US monetary policy affects cross-border bank flows. I find that an increase in US monetary policy uncertainty reduces cross-border bank lending. In response to higher uncertainty, banks reallocate their portfolio from foreign to domestic borrowers. Such cross-border effects are found to be higher in countries with low capital controls.

Using recent advances in the classification of exchange rate regimes, this paper finds no support for the popular bipolar view that countries will tend over time to move to the polar extremes of free float or rigid peg. Rather, intermediate regimes have shown remarkable durability. The analysis suggests that as economies mature, the value of exchange rate flexibility rises. For countries at a relatively early stage of financial development and integration, fixed or relatively rigid regimes appear to offer some anti-inflation credibility gain without compromising growth objectives. As countries develop economically and institutionally, there appear to be considerable benefits to more flexible regimes. For developed countries that are not in a currency union, relatively flexible exchange rate regimes appear to offer higher growth without any cost in credibility.

This paper empirically investigates the dynamic effects of monetary policy and uncertainty in monetary policy on U.S. dollar exchange rates using a vector autoregression (VAR) methodology. The federal funds rate (FFR) is considered a measure of U.S. monetary policy over the period 1984:3-1996:5 during which the Fed followed a consistent regime of targeting the FFR. The time-varying conditional standard deviation of FFR generated by a first order of autoregressive conditional heteroskedasticity (ARCH) model is used as a measure of uncertainty in U.S. monetary policy. Contractionary shocks to U.S. monetary policy are found to lead to persistent appreciation in both nominal and real dollar exchange rates, a pattern that is inconsistent with the simple overshooting hypothesis proposed by Dornbusch (1976). Increased uncertainty in U.S. monetary policy is found to lead to persistent appreciation in both spot and forward dollar exchange rates. It is found that shocks to uncertainty in monetary policy explain substantial portion of the variation in the dollar exchange rate against major currencies. Comparable results on the effects of the uncertainty in monetary policy are obtained for the United Kingdom. These results support the prediction of intertemporal asset pricing models with cash-in-advance constraints.