The Importance of Global Shocks for National Policymakers: Rising Challenges for Central Banks

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Another robustness check is the estimate of alternative versions of our SFAVAR.

First, we change the lag length from two to four lags with little consequences for our
results. Global liquidity, house and GDP shocks remain driving forces of the world
economy. In addition, we use different assumptions for identifying the global structural
shocks. In contrast to equation (5), we assume that the global short-term interest rate
reacts contemporaneously to global GDP and inflation but not to commodity prices,
global house prices and global liquidity. This change seems to be the most obvious one
for us, since monetary policy may have knowledge of the development of GDP and
inflation within the quarter. The impulse response functions in the FAVAR remained
very stable, apart from the responses after a global liquidity shock for which we find
some changes. For example, the common inflation factor rose significantly without any
time delay, thereby not being in line with economic theory. We interpret this result as
confirmation of our chosen identification strategy.

6. Policy conclusions

In this contribution, we have investigated whether there is increasing uncertainty for
monetary policy in the wake of globalization and whether central banks have become less
effective in influencing national liquidity conditions. In brief, our answer to both
questions is a clear “yes”. Hence, we feel legitimized to derive at least four policy
conclusions emerging from our analysis. First, global liquidity conveys additional
information about monetary conditions not summarized by national money and short-
term interest rates. Second, global liquidity restricts national monetary policy in its ability
to influence nominal and real variables, caused by, for example, the effect of global
liquidity on short-term interest rates. As a consequence, the influence of central banks on
domestic money supply is weakening. Third, national monetary policy is faced with an
increasing degree of uncertainty and might feel forced to act according to the so-called
Brainard conservatism principle. Fourth, the old question of optimal monetary policy
among interdependent economies powerfully reappears on the surface. In the following,
we elaborate a bit more on the third and the fourth policy conclusion.

Our third policy conclusion is that national monetary policy is faced with an
increasing degree of uncertainty. Needless to say, monetary policy always operates in an

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