Working Paper: NBER ID: w26031
Authors: Ricardo J. Caballero; Gunes Kamber
Abstract: Global risk-off shocks can be highly destabilizing for financial markets and, absent an adequate policy response, may trigger severe recessions. Policy responses were more complex for developed economies with very low interest rates after the Global Financial Crisis (GFC). We document, however, that the unconventional policies adopted by the main central banks were effective in containing asset price declines. These policies impacted long rates and inspired confidence in a policy-put framework that reduced the persistence of risk-off shocks. We also show that domestic macroeconomic and financial conditions play a key role in benefiting from the spillovers of these policies during risk-off episodes. Countries like Japan, which already had very low long rates, benefited less. However, Japan still benefitted from the reduced persistence of risk-off shocks. In contrast, since one of the main channels through which emerging markets are historically affected by global risk-off shocks is through a sharp rise in long rates, the unconventional monetary policy phase has been relatively benign to emerging markets during these episodes, especially for those economies with solid macroeconomic fundamentals and deep domestic financial markets. We also show that unconventional monetary policy in the US had strong effects on long interest rates in most economies in the Asia-Pacific region (which helps during risk-off events but may be destabilizing otherwise—we do not take a stand on this tradeoff).
Keywords: Risk-off shocks; Monetary policy; Financial markets; Policy put framework
JEL Codes: E40; E44; E52; E58; F30; F41; F44; G01
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Risk-off shocks (D81) | Stock market declines (G10) |
| VIX spike (E32) | Stock market declines (G10) |
| Risk-off shocks (D81) | VIX increase (G19) |
| Risk-off shocks (D81) | Treasury yield drop (E43) |
| Conventional monetary policy (E52) | Severity of sell-offs during risk-off episodes (E44) |
| Post-crisis policy put framework (H12) | Persistence of risk-off shocks (E32) |