Abstract
We assess the effect of the United States (US) and domestic monetary policies on emerging market economies (EMEs) using a panel factor-augmented vector autoregressive model. We find a US policy rate hike outstrips a tantamount hike in EME policy rates in its impacts on EMEs and discover that bond flows are more sensitive to interest rate differentials than are equity flows. Tighter global or EME-specific policy entails divergent responses of growth and inflation in EMEs: in particular, the output loss is greater in those EMEs with higher inflation. When US monetary policy tightens, bond and equity markets in EMEs are prone to outflows. Domestic policy alone is not enough to counteract the effects of global policy shocks on capital flows in EMEs.
Highlights
Amid increased interconnectedness through global financial market integration in recent decades, waves of global liquidity have produced cross-border spillover effects
This paper focuses on how policy rates in the United States (US) affect macroeconomic outcomes and capital inflows in EMEs that are distinct from outcomes and flows that result when their domestic policy rates change
While Edwards (2015) deals with a long-run policy contagion from the US to some EMEs, our study focuses on the dynamic responses of EMEs to global liquidity shocks driven by G5 monetary policy
Summary
Amid increased interconnectedness through global financial market integration in recent decades, waves of global liquidity have produced cross-border spillover effects. In the past few years, central banks in emerging markets have followed keenly the evolving changes in the global financial landscape— as advanced economies unwind global liquidity—along with the corresponding repercussions on macrofinancial stability in their economies Against this backdrop, this paper focuses on how policy rates in the United States (US) affect macroeconomic outcomes and capital inflows in EMEs that are distinct from outcomes and flows that result when their domestic policy rates change. | ADB Economics Working Paper Series No 532 into an unexpected shock to policy-driven global liquidity) reduces GDP growth of EMEs by 50 basis points over 3 years, while a 1 percentage point increase in the domestic policy rate of EMEs on average slows down their economies by 16 basis points. The section of the paper presents the FAVAR model used to reach these conclusions, while subsequent sections illustrate the effects of US and domestic monetary tightening and investigate the sources of fragility of EMEs
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