-6-
Third, we are examining whether structural breaks emerge on a global level but
also in the relation between global and national variables. In our view, this is of special
interest for national policy-makers, as they are supposed to react in a timely and
consistent manner when national economies are hit by global shocks.
2.2 Global variables and a "theory" of global shocks
Let us now turn to why we make use of specific global variables and to adhere to a theory
of global shocks in the context of our paper. In most of the literature, there is a focus on
commodity prices and real GDP when defining global shocks. However, we would like to
argue that it can also make sense to think in terms of other macroeconomic and financial
variables as global ones. More specifically, we investigate whether and to what extent
international co-movements concern not only real economic activity but also nominal
variables like, for example, monetary aggregates and interest rates and provide an
economic interpretation for the sources of common dynamics. We feel legitimized to do
so by keeping an eye on the main empirical pattern of the most recent financial and
economic crisis which is commonly modeled as a global demand shock and has been
characterized by a synchronous downturn of house prices (Federal Reserve Bank of
Kansas City, 2009). Our main focus in this paper is on the concept of global monetary
liquidity and of global short-term interest rates. Nevertheless, we also find significant
global house price shocks, technology shocks and long-term interest rate shocks. Let us
first address global monetary liquidity.
It is usually argued that there is a global money market only under a fixed
exchange rate system. By pegging the value of domestic currency to a foreign currency,
central banks make foreign currency a perfect substitute for domestic currency on the
supply side. Should the monetary authority in one country increase the money supply, the
domestic money supply would exceed domestic money demand. As a result, money flows
out through the balance of payments. The domestic balance-of-payments deficit must be
matched by a balance-of-payments surplus abroad. Thus, money supplies abroad must
also increase. Flexible exchange rates are assumed to eliminate this source of monetary
interdependence. National money becomes a non-tradable asset whose relative price (the
exchange rate) is assumed to be determined freely in foreign exchange markets. In