International monetary transmission in East Asia: Floaters, non-floaters, and capital controls § Soyoung Kim a, *, Doo Yong Yang b a Department of Economics, Seoul National University, San 56-1, Sillim-Dong, Gwanak-Gu, Seoul 151-746, Republic of Korea b College of International Studies, Kyung Hee University, 1 Seo Heon Dong, Gyeonggi-Do, Yongin-si 100-6008, Republic of Korea 1. Introduction The changes in the United States (US) interest rates have a strong impact on economic conditions in other countries. With the increasing globalization of most countries in the world, the influence of US monetary shocks has been a major concern in both developed and developing countries. Among several variables that the US monetary policy can affect, two variables—interest rate and exchange rate—have been widely studied and discussed both among academic researchers and within policymaking circles. 1 By studying the effects on these two variables, we can infer how two of the main international monetary transmission mechanisms work. From traditional Mundell–Fleming framework to New Open Economy Macro models, the exchange rate switching effect has been one of the most hotly debated transmission mechanisms. In particular, the exchange rate switching effect has been at the center of the ‘‘beggar-thy-neighbor’’ nature of monetary policy in the Mundell–Fleming framework under a floating exchange rate regime; a US monetary expansion may have a negative spill-over effect to other countries via an expenditure switching effect. On the other hand, the interest rate response of non-US countries can show the channel that result in the opposite effect. For example, a US monetary expansion can have a positive spill-over effect to other countries as other countries decrease their interest rates (and stabilize their exchange rates). Further, the response of interest rates may show whether monetary policy is independent of US monetary policy. These questions are even more interesting in the context of exchange rate regime choice, monetary policy independence, and the trilemma. The relative importance of interest rate and exchange rate effects is likely to depend on the choice of exchange rate regime; the exchange rate channel is likely to be important under a floating exchange rate regime while the interest rate channel is likely to be important under a fixed exchange rate regime. In addition, the issue of monetary independence has played a central role in the debate on the choice of exchange rate regimes. With internationally mobile capital, the policy choice under trilemma remains either exchange rate stability or monetary independency. Proponents of floaters have argued that floater countries would be able to pursue their own independent monetary goals, while advocates of hard peg have questioned Japan and the World Economy 24 (2012) 305–316 A R T I C L E I N F O Article history: Received 7 June 2011 Received in revised form 22 April 2012 Accepted 21 May 2012 Available online 29 May 2012 JEL classification: F42 F33 F31 Keywords: Structural VAR Monetary shocks Interest rate Exchange rate Exchange rate regime A B S T R A C T This paper analyzes the impacts of the United States (US) monetary shocks on East Asian countries using structural vector-autoregression (VAR) model. We find that the impacts of the US monetary shocks on East Asian domestic interest rates and exchange rates contradict conventional wisdom. The conventional exchange rate channel is unlikely to play much role in the transmission of the US monetary policy shocks to floaters in East Asian countries, excluding Japan. In these countries, the domestic interest rates respond strongly to the US interest rate changes, by giving up monetary autonomy, probably because of fear of floating. However, the domestic interest rate does not respond much in countries with fixed exchange rate regimes and capital account restrictions, such as China and Malaysia. This may suggest that the countries with fixed exchange rate regimes enjoy a higher degree of monetary autonomy, most likely with the help of capital account restrictions. ß 2012 Elsevier B.V. All rights reserved. § This work was supported by the National Research Foundation of Korea Grant funded by the Korean Government (NRF-2010-327-B00088). * Corresponding author. E-mail addresses: soyoungkim@snu.ac.kr (S. Kim), yangdy@khu.ac.kr (D.Y. Yang). 1 Numerous studies have analyzed the effects of monetary policy shocks on exchange rate (for example, Eichenbaum and Evans, 1995) and interest rate of other countries (for example, Kim, 2001). Contents lists available at SciVerse ScienceDirect Japan and the World Economy jo ur n al h o mep ag e: www .elsevier .c om /loc ate/jw e 0922-1425/$ – see front matter ß 2012 Elsevier B.V. All rights reserved. http://dx.doi.org/10.1016/j.japwor.2012.05.003