Impacts of US Interest Rates on Growth, Income Distribution, and Macroeconomic Policy Space in Developing Countries: A SFC Supermultiplier Model

Abstract

ABSTRACT This paper presents a stock-flow-consistent model in which growth is led by exports, government consumption, and consumption out of interest. It considers domestic and external debt dynamics and gross capital flows. The balance of payments constraint serves as a ceiling but not a floor for growth. Countries may choose to not fully use their external space to decrease public debts or accumulate international reserves. The model is applied to a comparative dynamics exercise to explore how a hike in foreign interest rates may impact growth and income distribution in a developing country under different policy responses. The shock forces the country to apply at least one contractionary macroeconomic policy or lose its reserves. Contractionary monetary policy may be the only tool to avoid external disequilibrium after the shock for countries with open capital accounts. Financial flows may impose trade-offs between short and long run policy objectives. Accumulated international reserves helps maintain expansionary policies and higher average growth rates after external shocks by providing liquidity in foreign currency.