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Monetary Policy Spillover to Small Open Economies: Is the Transmission Different under Low Interest Rates?

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Does the transmission of monetary policy change when interest rates are low? If so, how? We shed light on these questions by analyzing the cross-border transmission of monetary policy through bank credit channels. Specifically, we ask the following question: how do low and negative policy interest rates in core world economies affect bank lending in four small open economies—specifically, Canada, Chile, the Czech Republic and Norway?

We find that when interest rates are high, tightening of monetary policy in core economies can reduce credit supply in small open economies. In contrast, when interest rates in core economies are low, further expansionary monetary policy increases lending in small open economies, consistent with an international bank lending channel.

These results suggest that central banks in small open economies should consider the interest rates of core world economies, especially when those rates shift toward and away from the low end of the distribution.