What Happens to Inflation in Neighboring Economies in Responses to US Monetary Shocks?

This paper studies the responses of prices in foreign countries to US monetary shocks by employing country-level panel data. In this regard, we find that increases in the federal funds rate, when responding to cost shocks, decrease the GDP in neighboring economies to a relatively greater extent than when reacting to demand shocks. By contrast, there is little difference in the responses of the prices, if ever, while there is a huge difference across countries. We find that the Fed’s monetary tightening more likely depreciates the currency to a greater extent in countries with relatively higher vulnerability sufficiently to offset dis-inflationary effect led by a decline in output, thereby increasing inflationary pressure.