One Rate to Rule Them All: How U.S. Monetary Policy is Increasingly Controlling European Economies

Abstract: When the Fed raises the interest rates, it does so to steer domestic activity. However, the effects of such monetary policy may inadvertently spillover to other economies. This study employs the Global VAR approach to examine such spillover effects to European economies before and after the crisis. I find evidence that while US monetary policy tightening had virtually no effect on European output before 2007, its impact became substantial and significant after the crisis. What is more, European output drops by as much or even more than American output. The analysis reveals that spillovers seem to propagate mainly through the bond markets. Overall, this thesis supports the hypothesis in the literature that growth and financial conditions are largely determined by the 'Global Financial Cycle', which is on its turn driven by one rate. The US monetary policy rate.