The global interest rate factor displayed particularly large swings until the mid-1980s, partly due to sharp fluctuations in national interest rates (Cook and Hahn 1989). During this period, some countries focused on money supply targets (Brimmer 1983; Friedman 1982), such that high rate volatility reflected the impact of financial markets on interest rates rather than central banks’ decisions to adjust policy rates. The global rate factor was relatively stable in the 1990s and early 2000s before becoming more volatile again around the 2009 global recession. After a protracted period of stability in the 2010s, it has again displayed significant volatility since the beginning of the COVID-19 pandemic.

The behavior of the global inflation and output factors (in the bottom two panels of the Chart 12) is also consistent with some well-known global events. For example, the global inflation factor fell sharply just before or during global recessions, especially those associated with the 2008-09 global financial crisis and the COVID-19 pandemic, but also around the 1975 and 1982 global recessions. In addition, the global inflation factor fell during periods of sharp declines in oil prices (in 1986, 1990-91, 1997-98, 2001, 2008, 2014-16, and 2020).<sup>41</sup> The global output factor (measured by the highly volatile monthly IP series) shows even more short-term volatility, but also plunged during global recessions and rebounded in subsequent recoveries. The collapse and subsequent spike in output around the pandemic is particularly noteworthy and much more extreme than any other period in the sample—consistent with the evidence in Section III showing the unusual behavior of output and employment during the most recent rate cycle.

Although movements in the interest rate factor are mirrored by those for the global inflation and output factors during specific periods (such as the collapse in the global factor in all three variables during the 2008 recession), the correlations across the three global factors are fairly low at 0.110.26 for the full period. To better understand the evolutions of these variables over time, it is useful to decompose the role of these global factors in driving movements in individual economy’s interest rates, inflation, and output growth.

# IV.2.2 Importance of the Global Rate Factor over Time

Next, we examine the importance of global factors in explaining variations in national interest rates, inflation, and output. We estimate the contributions of the global factors to the variances of these variables, with results in Chart 13. Four results are worth highlighting. First, the global interest rate factor plays a significant role in driving fluctuations in national interest rates; it accounted for nearly 15 percent of the interest rate variation, on average over the full period.<sup>42</sup> Although this share is lower than the global factor in inflation and output growth over the full period, it is sizable considering that our sample includes a diverse group of countries with monetary policy frameworks that have changed meaningfully over this long period.<sup>43</sup>

> 41 Baffes et al. (2015) presents an analysis of the periods of sharp declines in oil prices. Ha et al. (2023) examines the role of oil prices in driving national inflation.

> 42 Over the full period, the global interest rate factor accounted for the largest share of variation in the euro area (47 percent), followed by Switzerland (32 percent), Japan (18 percent), and Canada (12 percent). In the post-1999 period, the role of the global rate factor became more pronounced in almost all economies and was particularly important in explaining the interest rate variation in the United States (61 percent), the euro area (58 percent), Canada (55 percent), and Australia (49 percent), but much smaller in Japan (18 percent).

> 43 Other studies on the cross-country comovement of interest rates include Lindenberg and Westermann (2012), Mandler and Scharnagl (2022), and Henriksen, Kydland, and Sustek (2013). Studies on the importance of the global factor in interest rates include Ha et al. (2020), Chatterjee (2016), and Crucini, Kose and Otrok (2011).

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