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On February 6, 2020, the Reserve Bank of India left key interest rates unchanged at the conclusion of its scheduled Monetary Policy Committee (MPC) meeting, citing a strong growth outlook of 6 per cent for the year as one of the reasons for its decision. Within a few weeks, the Covid-19 crisis exploded and sent global financial markets into a tailspin.
The Nifty 50 began its descent on March 5 to reach a low of 7,610.23 on March 23. In response, the MPC lowered its policy repo rate on March 27 to 4.40 per cent from 5.15 per cent and further down to 4 per cent on May 22. Both meetings were unscheduled.
Similar events were unfolding in other countries including the US and Europe. On January 29, the US Federal Reserve (Fed) left its target federal funds rate unchanged, citing low inflation and strong employment data. As the crisis unfolded, it reversed its stance and lowered the federal funds rate to near zero on March 15. The Dow Jones Index reached a low of 18,591.23 on March 23, the same day as the Nifty 50.
In Europe, the situation was different because the monetary policy rate was already negative. The European Central Bank (ECB) announced on March 18 that it planned to inject liquidity of €750 billion into the economy. Similar actions in other countries provided an assurance to financial markets that central banks were willing to implement accommodative policies and global stock markets began an upward momentum.
An interesting question that emerges from these events is whether the RBI and the ECB waited to follow the lead of the Fed. In the past, studies have shown that monetary policy actions by the Fed usually lead to similar actions by other central banks. Fed actions also had reverberating effects on financial markets around the world, while announcements by other central banks had limited effect outside of their country.
Our recent research sheds light on whether central bank actions influence their peers and financial markets. In particular, we examine the central bank announcements of six Asia-Pacific countries — Australia, China, India, the Philippines, South Korea and Taiwan, and three Western countries, the US, the UK and Europe.
Our results show that a country’s announcement of a monetary policy rate change is often followed by similar announcements in other countries.
However, we could not identify any one dominant country whose announcement triggers similar actions by other central banks. A rate change by the Fed triggered changes in other countries but rate changes in other countries also affected rate changes in the US. The growth, integration and interdependence of global financial markets in recent years have increased coordination among central banks and reduced the dominance of one on others.
Financial markets
What about financial markets? Do they respond to central bank rate changes of other countries? Our study first examined the reaction of market interest rates to announcements of central banks in their own country. The results show that central bank announcements in India and China were successful in transmitting into both short- and long-term rates. In contrast, in Taiwan, South Korea and Australia, they could only affect short-term rates. In the Philippines, all market interest rates remained unaffected by announcements.
We next studied the response of market interest rates to central bank announcement of other countries. The results showed the monetary policy announcements of India and China affected the market interest rates of the other four countries. The announcements by India affected short-term market interest rates of other countries while announcements by China affected only long-term rates. One explanation for the difference is that changes in China are infrequent and, therefore, signal long-term policy changes.
The results also showed that central bank announcements of three major countries, the US, the UK and Europe, had only a marginal impact in the Asia-Pacific region. Monetary policies are more intertwined within the Asia-Pacific countries than with the nations of the West.
In sum, the interconnectedness of financial markets has resulted in better coordination among central banks worldwide. Central bank actions trigger similar actions by peers but no one country is dominant. Within the Asia-Pacific region, the monetary policy actions of India and China have a bigger influence on regional financial markets.
Rama is Professor of Finance,
IIM-Calcutta, and Anoop is Professor, Hofstra University, New York
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