Exposure to Dollar, financial Openness, and the heterogeneous impact of US monetary spillover

Abstract

This paper studies how country heterogeneities, especially in their (1) net exposure to dollar debt and (2) financial openness affect the propagation of US monetary shocks into peripheral advanced and emerging economies. We contribute to the understanding of how interest rate and GDP responses of emerging countries depend on both their dollar liability and financial openness, as well as the interaction between these two factors. Specifically, we find that economies with higher debt dollarization have higher interest rate responses to contractionary US monetary shocks to prevent negative balance sheet effects. We also find that GDP decreases by more for economies with high debt dollarization if their financial openness is high. Using capital control as the de jure measure of financial openness, we obtain similar results that GDP decreases by more for countries net short of dollar if capital control is low, and at the same time, GDP is higher for countries with higher capital control if they are more indebted in dollar. Combined, these imply that capital control helps dampen negative US monetary spillover, and the benefit from imposing capital control is larger for countries that are more indebted in dollar.