International Spillovers of Conventional versus New Monetary Policy

We compare the international spillovers of conventional and new monetary policy shocks from a large economy to a small open economy (SOE). Building on Sims and Wu (2021,Journal of Monetary Economics, Vol. 118, pp. 135–160), we employ a medium-scale New Keynesian model that features the major tools of new monetary policy and conventional monetary policy in a uni…ed framework. We extend their model to an open economy setting and use it as a measurement device to quantify the spillovers and study the economic mechanisms behind them. In our empirical application, Canada is the SOE and the US is the large economy. We …nd that the US expansionary monetary policy shocks that have the same positive effect on US GDP (a 0.5% increase), cause different changes to Canada's private bond yield depending on the nature of the shock. For example, if the shock is due to forward guidance, Canada's private bond yield increases by 0.15% but if the shock is due to uantitative easing (QE), the yield drops by 0.13%. We also simulate counterfactual monetary policy scenarios for the US and Canada around the Great Recession of 2008. Three main conclusions emerge from these simulations: (1) Had the Fed increased the size of its QE, the recession in the US would have been milder but Canada would have had a steeper drop in GDP; (2) had the Bank of Canada followed the Fed and engaged in QE of its own by doubling the size of its balance sheet from 3% to 6% of GDP, the drop in Canada's GDP would have been 50% smaller; and (3) had the Fed engaged in a negative interest rate policy by letting its policy rate drop to -0:5%, instead of keeping it at the zero-lower bound, the effects on Canadian economy would be very similar.