availability of data on the policy interest rate, output, and inflation for the full sample period. We use the same data for each of the domestic variables as used in the analysis in earlier sections and as described in Appendix Table 2. The data for the global variables is also the same as that used in the previous section, with the addition of oil price growth, which is measured as the month-on-month growth rate of the nominal oil price (the simple average of Dubai, West Texas Intermediate, and Brent benchmarks) from the World Bank’s monthly Pink Sheet of commodity prices.

# V.2. Drivers of Rate Cycles

This section estimates the model described above in order to examine the importance of the seven different global and domestic shocks in driving rate cycles using standard forecast error variance decompositions. We use simple averages across countries in order to focus on the aggregated results of these decompositions and learn from the broader cross-country experience. We analyze the results over the full sample from 1970-2023, the five shorter sub-periods used in earlier sections, during the economy-specific easing and tightening phases identified in Section II and then for these two phases over shorter windows (the five sub-periods and for Highly Synchronized Tightening periods).

# V.2.1. Drivers of Rate Cycles over the Full Sample (1970-2023)

The left side of Table 2 and Chart 14 present the contributions of the seven global and domestic shocks to the variance of national policy interest rates over the full sample period from 1970-2023, including the combined contributions of all the global shocks and all the domestic shocks. On average, the global shocks together accounted for nearly 26 percent of the variation in interest rates in the five economies, ranging from 14 percent (in the United States) to 55 percent (in the euro area).<sup>57</sup> Among the global shocks, global demand shocks played the largest role in driving policy rates, accounting for 10 percent of the average variance in interest rates. The other global shocks (to monetary policy, supply, and oil prices) explained, on average, from 4 to 6 percent of the variation in rates.

In contrast, domestic shocks explained the lion's share of the variance of domestic policy rates, accounting for almost three-quarters of rate fluctuations on average over the full period. Among the domestic shocks, demand shocks were the main drivers of the variation in interest rates, with an average contribution of about 34 percent, followed by domestic monetary policy shocks (accounting for nearly 31 percent). Domestic supply shocks played a much smaller role, with an average contribution of nearly 10 percent.

change the global factor estimates. In addition, given the potential feedback effects, our FAVAR model with monthly data does not impose any restrictions between the global and domestic variables other than contemporaneous sign and zero restrictions. We also estimate the results excluding the US from the G5 sample, however, and the headline results for the averages across countries are robust.

> 57 Global shocks account for a smaller share of the variation in policy rates than domestic shocks in all five economies except the euro area. This finding likely reflects the euro area’s stronger global trade and financial linkages and much deeper integration with global supply chains. The dominant role of the global shocks in euro area interest rate cycles is consistent with other studies in the global business cycle literature. For example, Ha et al. (2020) and Kose, Otrok, and Prasad (2012) report a larger share of the global factor or global output factor in the euro area than other economies.

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