Spillover effects of U.S. business cycle shocks on monetary policy in Pacific Alliance Countries (PAC)

This paper investigated the spillover effects of U.S. structural shocks on the monetary policy of Pacific Alliance (PA) countries. We began by estimating a backward-looking Taylor rule using panel data, incorporating the U.S. output gap and policy rate as external factors to assess the sensitivity of PA central banks to U.S. economic conditions. Additionally, unlike traditional approaches that treat foreign macroeconomic variables as exogenous, we recognized that they are subject to supply and demand shocks. To address this, we employed a two-stage strategy. First, we used a structural vector autoregression (SVAR) with long-run restrictions to identify these shocks. Then, we evaluated the dynamic responses of PAC policy rates using a distributed lag model. Our findings revealed the following: (i) U.S. GDP and policy rates plays a significant role in the monetary policy reaction functions of PA central banks; (ii) the nature of the shock—whether demand or supply—results in differing responses, with PA countries generally reacting more strongly to U.S. demand shocks; and (iii) the persistence of these responses varies across countries.