From the paper by Silvia Miranda-Agrippino and Helene Rey , “World Asset Markets and the Global Financial Cycle”,
We find evidence of powerful monetary policy spillovers from the US to the rest of the world. When the US Federal Reserve tightens, domestic output, investment, and inflation contract. But, importantly, we see also significant movements in international financial variables: the global factor in asset prices goes down, spreads go up, global domestic and cross-border credit go down very significantly and leverage decreases, first among US broker-dealers and for global banks in the Euro area and the UK, then among the broader banking sector in the US and in Europe.
We also find evidence of an endogenous reaction of monetary policy rates in the UK and in the Euro area. Hence, we find that US monetary policy is an important driver of the Global Financial Cycle.
This is an important result as it challenges the degree of monetary policy independence enjoyed by countries around the world, even those who have flexible exchange rates such as the UK or the Euro Area. This fits with the claim of Rey (2013) that the Mundellian trilemma may have really morphed into a dilemma: as long as capital flows across borders are free and macro prudential tools are not used to control credit growth, monetary conditions in any country, even one with a flexible exchange rate, are partly dictated by the monetary policy of the centre country (the US).
In other words, exchange rate movements cannot insulate a country from US monetary policy shocks and a flexible exchange rate country cannot run a fully independent monetary policy.