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

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1. Introduction

Global economic integration has been spreading markedly in recent years. This is both
true for goods and financial markets. Macroeconomic variables in one country should
therefore increasingly reflect events occurring in the rest of the world. Even the housing
sector, which is usually regarded as a national phenomenon, has seemingly become more
synchronized across countries. As indicated by the latest events, strong rises in residential
property prices in the US and some parts of Europe were followed by rapid declines. As
national economies become more interconnected, a thorough understanding of the global
economy and its effects on domestic economic activity is crucial. The ability to gauge the
timing and the magnitude of international spillovers is of particular relevance, since it
contributes to a better assessment of the development in one country or region.

The rapid speed of globalization on goods and financial markets is beneficial, but
may also have drawbacks for national policymakers. International spillovers and global
shocks can limit the autonomy of national monetary and fiscal policy. For example,
international capital flows are influencing national monetary conditions, thereby
curtailing the ability of central banks to influence national real activity and prices.

The questions we are investigating in this contribution are therefore threefold.
First, what are the major shocks and transmission channels which are driving the global
economy? Second, to what extent have global factors affected the determination of key
macroeconomic variables in the G-7 countries? We quantify the speed and size of
spillovers that occur following a shock originating from the global economy. Third, what
can national economic policy do in the light of international spillovers and what should
national policymakers do? More specifically, we investigate whether there is increasing
uncertainty for monetary policy in the wake of globalization and whether there is a
negative time trend in the effectiveness of national monetary policy when trying to steer
national liquidity.

The paper proceeds as follows. In section 2, we relate our contribution to the
literature and develop the global perspective before we turn to the selection of the data
and variables in section 3. In section 4, we briefly explain the Factor-Augmented Vector
Autoregression (FAVAR) methodology. In section 5, we display our estimation results

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