Working Paper No. 693
Ambrogio Cesa-Bianchi and Andrej Sokol
Recent empirical evidence on the cross-country synchronization of credit spreads in response to US monetary policy shocks has led to the notion of an ‘international credit channel’ of US monetary policy. This paper provides novel evidence on the existence of an international credit channel for the transmission of US financial shocks across borders, and compares their impact to US monetary policy shocks. We identify monetary policy and financial shocks by combining the external instruments approach with sign restrictions in a two-country SVAR for the United States and the United Kingdom. Adverse US financial shocks trigger a sharp and persistent contraction in the US economy, and an increase in US credit spreads. Crucially, this tightening in US credit conditions is quickly transmitted internationally, leading to an increase in credit spreads and a slowdown in economic activity in the United Kingdom. Unlike financial shocks, monetary policy shocks do not seem to induce as much international co-movement. Our results are in line with general equilibrium open economy models with credit market imperfections and a high degree of financial integration.