Download Research on U.S. Monetary Policy Shocks on Foreign Trade of

EASTERN ACADEMIC FORUM
Research on U.S. Monetary Policy Shocks on Foreign Trade of
Zhejiang Province in Open Economy
CEN Lijun1
Zhejiang University of Technology, China, 310023
[email protected]
Abstract: The article empirically investigates international transmission and spillover effects of United
States monetary policy on foreign trade of Zhejiang Province using SVAR model and its impulse
response function with data from August 2007 to May 2013. It shows that United States monetary policy
has complicated effects on exports and significant negative effects on imports of Zhejiang. Thus China
needs to be actively involved in the coordination of international monetary policy. Zhejiang Province
needs to encourage enterprises to accelerate developing stronger and expanding overseas while the
enterprises themselves should keep alert from time to time to effectively prevent international risk.
Keywords: Open economy, Monetary policy, Foreign trade, Shocks
1 Introduction
With the development of economic globalization and country openness, countries become much more
interdependent on each other. The monetary policy of a country can transmit to other countries via
various channels, called international spillover effects of the monetary policy. After the 2007 financial
crisis, many countries have adopted expansionary monetary policies to ease the crisis and recover
domestic economic growth, while the policies also have an impact on other countries’ domestic
economy. It is one of the instances. As one of the earliest opening-up of China's provinces, foreign trade
dependence of Zhejiang Province in 2011 was 61.83%, while the national average was 49.74%. Exports
of Zhejiang to United States accounted for 16.14% of the total exports. Whether United States
expansionary monetary policy has an impact on foreign trade of Zhejiang, and how serious are the
international spillover effects? This is intended to be discussed in the article.
2 Literature Review
In open economy, a country's monetary policy will, through multiple channels, such as international
trade, international investment and exchange rate, transmit to other countries and affect their economy,
namely international spillover of monetary policy. Many scholars have carried out theoretical analysis
and empirical tests about international transmission and spillover effects of monetary policy. In theory,
the earliest research was dating back to 1962 by Mundell. He studied countries interdependence and
transmission effects of the policies using a two-country open model. Canzoneri & Gray (1985) analyzed
three spillover effects of monetary policy in the international monetary policy coordination game model,
which were symmetric positive spillover effect, symmetric negative spillover effect, and asymmetric
spillover effect. New open economy macroeconomics (NOEM), represented by Obstfeld & Rogoff
(1995) (hereinafter referred to as OR), investigated international transmission mechanisms and welfare
of international coordination of macroeconomic policies. Obstfeld & Rogoff (1995)’s model was a
benchmark framework in NOEM. It was different from the traditional sticky-price Keynesian models
and the modern flexible-price inter-temporal models. It investigated international spillover effects of
fiscal and monetary policies under the premise of global macroeconomic dynamics, which was the
foundation for research on open economy macroeconomic policies. Since then, many scholars made
1
This paper was a part of the achievements of Zhejiang Provincial Natural Science Foundation Programme
(LQ13G030014) and Education of Zhejiang Province Programme (Y201329856).
346
EASTERN ACADEMIC FORUM
extension on OR (1995). Carre & Collard (2003), Steffen (2005) introduced currency holdings in the
form of cash constraints in their utility functions. Corsetti & Pesenti (2001), Ganelli (2003) introduced a
specific labor market into the utility function. Carre & Collard (2003) assumed the indivisibility of
consumption and leisure. Warnock (1998) considered the consumer preference for domestic goods in the
utility function. Tille (1999) argued that, the international specialization of production make elasticity of
substitution between domestic goods must be higher than the elasticity of substitution between domestic
and foreign goods. OR (1998) took the uncertainty into account. OR (2000) introduced in nontraded
goods on OR (1995). OR (2002) further explored the effects of uncertainty on international transmission
of policy and its mechanisms. Devereux & Engel (2000) compared the transmission of international
economic policies and the optimal choice of monetary policy under producer currency pricing (PCP)
and local currency pricing (LCP) respectively when productivity shocks and money supply shocks exist.
In terms of empirical, Frankel & Rochkett (1988), with 12 different versions of the Mundell-Fleming
-Dornbusch model, investigated the impacts of United States monetary policy impacts on the rest of the
world. Selover & Round (1996) found that Japan's monetary policy for Australia with one-way
spillovers, while Australia monetary policy in Japan there is no spillover. Cushman & Zha (1997),
introducing variables such as exchange rates, import and export, tested the United States and Canada
between the monetary transmission mechanisms. Koray & McMillin (1999) examined the impact of
United States monetary policy on exchange rate and trade balance between United States and Canada
under the floating exchange rate system. Holman & Neumann (2002), Arin & Jolly (2005), Kozluk &
Mehron (2008) examined shocks of monetary policy between United States and Canada, Australia and
New Zealand, China and its major Asian trading partners separately using the VAR (vector
autoregression) models.
Studies on international shocks of monetary policy in China were much less. Junxue Jia & Guo
Qingwang (2006) using 1992-2005 years quarterly data, tested whether United States economic shocks
affect Chinese domestic economy and confirmed it. Hong Wu & Liu Wei (2009) suggested that United
States monetary policy have a significant international spillover effect on outputs, net exports and prices
in other countries in the world.
Considering the existing literature, theoretical studies are relatively rich and empirical ones are rather
few, much less about the financial crisis in 2007 and its shocks on Zhejiang Province, but the effects
indeed exist. This article will use a SVAR model and its impulse response function to study international
transmission and spillover effects of United States monetary policy on foreign trade of Zhejiang.
3 Foreign Trade of Zhejiang Province Before and After the Financial Crisis
3.1 Overall development of foreign trade
Figure 1 describes the overall development of foreign trade of Zhejiang Province before and after the
financial crisis. Imports and exports of Zhejiang Province grew steadily after China’s reform and
opening up, and fast particularly after entering the WTO. However, due to the financial crisis of 2007, it
was negative growth in 2009. Foreign trade returned to positive growth in 2010 and 2011.
347
EASTERN ACADEMIC FORUM
Figure 1 Foreign trade of Zhejiang Province (1986-2011) (billion dollar)
Source: Calculations based on data from the Zhejiang Statistical Yearbook.
3.2 Foreign trade of classified goods
Figure 2 describes the exports of classified goods of Zhejiang Province. Exports of primary products
have grown much more smoothly since 2000, and were less affected by financial crisis compared with
industrial products. Exports of mechanical and electrical products were affected by financial crisis
obviously.
Figure 3 is the imports of classified goods of Zhejiang Province. Imports of industrial products have
grown faster than imports of primary products, and mechanical and electrical products. Mechanical and
electrical products were affected significantly by 2007 financial crisis. Imports of industrial products
recovered fastest after the financial crisis.
Figure 2 Exports of classified goods of Zhejiang Province (2000-2011) (billion dollar)
Source: Calculations based on data from the Zhejiang Statistical Yearbook.
348
EASTERN ACADEMIC FORUM
Figure 3 Imports of classified goods of Zhejiang Province (2000-2011) (billion dollar)
Source: Calculations based on data from the Zhejiang Statistical Yearbook.
4 Econometric Analysis
VAR model and its impulse response function can describe the dynamic relationships and transmission
mechanisms among economic variables. In the article, SVAR model, which was derived from VAR
model, is used to empirically test international transmissions and spillover effects of United States
monetary policy on foreign trade of Zhejiang Province.
4.1 Variables and data
As Holman & Neumann (2002), M2 is United States monetary policy and data source from BvD EIU
Country Data. EXP and IMP are exports and imports of Zhejiang Province, and data source from DRC
net. Due to the financial crisis, United States started adjusting interest rates significantly in August 2007,
so the sampling interval is from August 2007 to May 2013. The data are seasonally adjusted and natural
logarithm.
4.2 Data tests
SVAR model requires the data sequence smooth. The data need a stability test before modeling. When
all variables meet the stationary sequence or when a cointegration relationship exists can only build
SVAR models. Application of Eviews6.0 software, ADF unit root tests suggest that M2, exports and
imports are first-order integer sequences in 1% significance level. Johansen tests show that M2 and
foreign trade of Zhejiang Province have 2 cointegration relationships. Therefore, meet the conditions for
constructing SVAR models.
Null hypothesis
Table 1 Cointegration test
Eigenvalue
Trace Statistic
5% Critical Value
P value
0.3564
51.2693
35.19288
0.0004
*
0.2327
21.7402
20.2618
0.0311
At most2
0.0578
3.9892
9.1645
0.4137
Null hypothesis
Eigenvalue
Max-Eigen Statistic
5% Critical Value
P value
None*
At most1
*
None
0.3564
29.5291
22.2996
0.0041
*
0.2327
17.7510
15.8921
0.0253
At most2
0.0578
3.9892
9.1645
0.4137
At most1
349
EASTERN ACADEMIC FORUM
4.3 Modeling and impulse response analysis
Based on the above analysis, the SVAR model about international spillover effects of United States
monetary policy on foreign trade of Zhejiang Province is:
Yt  {LnM 2, LnEXP, LnIMP}
The Cholesky lower triangular decomposition matrix of the corresponding inner variables is:
1
As t  A0  t , have
1
0
0  

 M 2    M 2 
A0 t   a21 1
0   EXP     EXP 


 

a
a
1 
 31 32  IMP   IMP 
 t is the structured perturbations of SVAR model,  t is the simplified perturbations of the
corresponding VAR model, aij is the estimating coefficients. According to aij , matrix A0 is
calculated, therefore shocks of United States monetary policy is identified.
Test United States monetary policy shocks on foreign trade of Zhejiang Province after the financial
crisis using SVAR model and monthly data. The positive shock to United States money supply
corresponds to expansionary monetary policy. Figures of impulse response functions describe the
dynamic response of economic variables to a standard deviation of money supply shock. Horizontal axis
indicates the periods. The vertical axis represents the size of the impulse response function. The red
dotted line represents plus or minus twice the standard deviation (  2S.E.).
Response to Cholesky One S.D. Innovations ± 2 S.E.
Response of LNEXP to LNM2
Response of LNIMP to LNM2
.12
.12
.08
.08
.04
.04
.00
.00
-.04
-.04
1
2
3
4
5
6
7
8
9
-.08
10
1
2
3
4
5
6
7
8
9
10
Figure 4 The impulse response function
Figure 4 left is the impulse response function of Zhejiang exports to the United States monetary policy
changes. It is complicated. United States expansionary monetary policy has a faint positive spillover
effect on exports of Zhejiang Province at the first period, but at the second period to zero. It is negative
later until the 10th to zero again.
After the financial crisis, United States has taken a series of conventional and unconventional monetary
policies. Especially when there are no adjustments in interest rates, it has launched four rounds of
quantitative easing monetary policies, which have a huge impact on the global economy and China's
domestic economy. United States quantitative easing monetary policies devalue US dollar. On the one
hand, exporters' profits reduce, thus the will of export weaken. On the other hand, the pressure of RMB
appreciation is increasing, which seriously affects the exporters’ expectations and competitiveness,
350
EASTERN ACADEMIC FORUM
therefore inhibits the development of exporters.
Figure 4 right shows the impulse response function of Zhejiang imports to the United States monetary
policy changes. It is immediate and significant. It is negative, decreasing continually until the 10th
period of zero. United States quantitative easing monetary policies will promote the price of agricultural
products and energy in the world market. These goods are the main imports of Zhejiang Province. Price
rises will curb imports to some extent.
5 Conclusions and Suggestions
In the short term, United States expansionary monetary policy has negative international spillover
effects of trade of Zhejiang Province after the financial crisis. However, it is gradually weakened and
tends to zero over time. In this regard, firstly, China needs to be actively involved in the coordination of
international monetary policy to avoid Western developed countries’ “beggar my neighbor” policies
negatively affect on the domestic economy, especially on coastal provinces with higher levels of
openness. Secondly, Zhejiang Province needs to encourage enterprises much bigger and stronger,
accelerate the Group expand overseas, thus speed up industrial restructuring and upgrading. Thirdly,
enterprises in Zhejiang Province need to be on high alert from time to time in order to effectively
prevent international risk. They also have to strengthen their ability to anticipate, resist and cope with
international risk.
References
[1]. Obstfeld, M. & Rogoff, K. Exchange Rate Dynamics Redux [J]. The Journal of Political Economy,
1995, 103 (3): 624-660
[2]. Obstfeld, M. & Rogoff, K. New Directions for Stochastic Open Economy Models [J]. Journal of
International Economics, 2000, 50: 117–153
[3]. Obstfeld, M. & Rogoff, K. Global Implications of Self-oriented National Monetary Rules [J]. The
Quarterly Journal of Economics, 2002, 117 (2): 503-535
[4]. Tille, C. The Role of Consumption Substitutability in the International Transmission of Shocks”,
Federal Reserve Bank of New-York Staff Report, 1999, No.67
[5]. Jia Junxue, Guo Qingwang. Economic Openness, External Shocks and Macroeconomic Stability:
the Analysis of U.S. Economic Shocks to China. Journal of Renmin University of China, 2006 (6)
(in Chinese)
[6]. Wu Hong, Liu Wei. An Empirical Study on the International Transmission Effect of the U.S.
Monetary Policy and Its Impacts. Journal of Qualitative and Technical Economics, 2009 (6). (in
Chinese)
351