What Happens to Inflation in Neighboring Economies in Responses to US Monetary Shocks?

Abstract

This paper studies the responses of prices in foreign countries to US monetary shocks by employing country-level panel data. In this regard, we find that increases in the federal funds rate, when responding to cost shocks, decrease the GDP in neighboring economies to a relatively greater extent than when reacting to demand shocks. By contrast, there is little difference in the responses of the prices, if ever, while there is a huge difference across countries. We find that the Fed’s monetary tightening more likely depreciates the currency to a greater extent in countries with relatively higher vulnerability sufficiently to offset dis-inflationary effect led by a decline in output, thereby increasing inflationary pressure.