# **Appendix III. Evidence on U.S. Monetary Policy Transmission**

In this section, we focus on the effects of U.S. monetary policy shocks on the financial markets and macroeconomic variables in EMEs. Our empirical framework enables us to investigate the transmission of U.S. monetary policy shocks as U.S. monetary policy instruments and the VIX index are incorporated as control variables. We use shadow short-rate point estimates, constructed by Wu and Xia (2016), to address zero lower bounds (ZLB) and unconventional monetary policies implemented during the period after the global financial crisis. However, since these rates encompass both endogenous (anticipated) and exogenous (unanticipated) components of monetary policies, we also implement the analysis using the pure monetary policy surprises estimated by Jarocinsky and Karadi (2020). Additionally, we present the responses of the variables following an increase in VIX as a proxy for global financial uncertainty for the purpose of comparison. We then compare the responses of domestic variables to U.S. monetary policy shocks to those induced by domestic monetary policy shocks.<sup>43</sup> Figure A11 presents the impulse responses of domestic macroeconomic and financial variables in EMEs to U.S. monetary policy rates (“SHADOW”), U.S. monetary policy surprises (“CJKMP”), and the VIX index (“VIX”).

**Foreign exchange rates.** We first discuss the dynamics of foreign exchange rates per US dollar, a primary channel for international monetary spillovers. Initially, following a contractionary U.S. monetary policy shock, the domestic currencies of these economies experience immediate depreciation, followed by a gradual appreciation over several months. This pattern aligns with the predictions of the overshooting theory by Dornbusch (1976). Interestingly, there is no evidence supporting the delayed overshooting or foreign exchange rate puzzle proposed in previous studies, corroborating recent findings (Rogers et al. 2018; Bjørnland 2009).

**Equity prices.** Following a contractionary U.S. monetary policy shock, equity prices in the EMEs spontaneously decrease by 5–20 percent, and these impacts last for at least a few months. Notably, the response of EME equity prices differs depending on the nature of U.S. monetary policy shocks. In Chile, Mexico, and India, equity prices exhibit positive response following an increase in U.S. shadow interest rates. However, when tested with the pure monetary policy shocks, equity prices decline significantly in all EMEs. These contrasting results suggest that the positive response of equity prices following the shadow rate increase was mainly driven by the endogenous reactions of the Federal Reserve to future demand or supply shocks or central bank information shocks that led to a rise in U.S. monetary policy instruments.

**Interest rates.** The short-term interest rates display similar reactions across the EMEs. Initially, on impact, the yields respond positively to the shock, but these effects gradually diminish over approximately a year.<sup>44</sup> However, following pure monetary policy shocks, interest rates decline over time in most EMEs. This decline may reflect the reductions in aggregate demand due to U.S. monetary tightening or alternatively, the subsequent response of monetary policies in EMEs as reflected in the responses of policy rates in these economies.

> 43 When U.S. monetary policy rates are included as an endogenous variable, the empirical results do not differ much. 44 These estimates are comparable to findings of studies on advanced economies. For example, Bluedorn and Bowdler (2011) utilized US monetary policy shocks sourced from Romer and Romer (2004) and showed that the short-term interest rates in Canada and the UK respond by up to 0.5–1.0 percentage point following a one percentage point increase in the Federal Funds Rate.

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