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| We show that global supply and demand shocks are important drivers of interest rate co-movement across seven advanced economies. Beyond that local structural shocks transmit internationally via aggregate demand channels and central banks react predominantly to domestic macroeconomic developments: unexpected monetary policy tightening decreases most foreign interest rates while expansionary local supply and demand shocks increase them. To disentangle determinants of international interest rate co-movement we use a Bayesian structural panel vector autoregressive model accounting for latent global supply and demand shocks. We identify country-specific structural shocks via informative prior distributions based on a standard theoretical multi-country open economy model. |
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