Uncovering asymmetrical contagion effects: US monetary policy and emerging markets

Abstract

The impact of U.S. monetary policy (USMP) on domestic interest rates and goods markets in Emerging Market Economies (EMEs) remains a subject of ongoing debate. We investigate the fluctuations in U.S. interest rates across 17 inflation-targeting EMEs with flexible exchange rates from 2000–2020. Our findings reveal asymmetric contagion effects, with U.S. interest rate decrease having a more significant short-term impact than rate hikes. Long-term U.S. rates minimally influence EMEs’ domestic rates. Resilience is observed in EMEs with robust GDP growth and favorable trade balances, while increased capital inflows and stock market surges heighten contagion risks. Focusing on the short-term contagion effect on goods markets through international trade drivers, we find that global capital flows and US dollar fluctuations, combined with a rise in the FED rate, contribute to the deterioration of EMEs’ trade balance. The study underscores the need for EMEs to monitor and respond to U.S. monetary policy changes for financial stability and advocates for enhanced international dialogue among policymakers.