U.S. monetary policy and emerging markets post COVID
Hoek et al. in this note identify two factors which influence the spillovers to emerging market economies (EMEs) of U.S. monetary policy:
- The first factor is the reason for the change in U.S. interest rates. If interest rates increase due to favorable growth prospects, the effect on emerging markets financial markets will tend to be benign. If higher rates are driven mainly by worries about inflation or a hawkish turn in Fed policy the spillovers to this will likely be more disruptive for EMEs;
- The second key factor influencing the spillovers from U.S. monetary policy is the domestic conditions in the EMEs themselves; financial conditions in economies with higher macroeconomic vulnerabilities tend to be more sensitive to a given rise in U.S. interest rates.
[H]igher U.S. Treasury yields can result in a significant tightening of EME financial conditions but such effects importantly depend on the drivers of higher yields and domestic conditions in EMEs. Our results help explain limited financial spillovers to EMEs from higher U.S. Treasury yields so far this year, as the increases appear to have been substantially driven by improved growth prospects for the United States. That said, were future increases in interest rates to reflect heightened concerns about inflation, vulnerable EMEs would likely come under pressure.
Are Rising U.S. Interest Rates Destabilizing for Emerging Market Economies?
By: Jasper Hoek, Emre Yoldas, and Steve Kamin – Federal Reserve Board
How did emerging markets fare during Covid-19
Şebnem Kalemli-Özcan puts forth interesting information about what policies emerging market economies followed during the pandemic :
- Banking and corporate debt flows for emerging markets stayed intact in 2020;
- Emerging market economies put together fiscal support worth only 6 percent of their GDP on average compared with average support of about 20 percent of GDP in advanced economies;
- Fifteen emerging market economies, lacking the resources to mount fiscal packages resorted to QE. So far, most of these programs, though small, have been successful, with a few exceptions where central banks did not have the credibility to assure markets that they would not fund the government indefinitely.
The Federal Reserve’s post-pandemic stance will expose vulnerabilities in emerging markets with high private external debt
By: Şebnem Kalemli-Özcan – University of Maryland
U.S. policies going forward and their impact on emerging market economies
The U.S. can follow two strategies, according to Aizenman and Ito, in order to exit the Covid-19 induced high debt. Each strategy will have differing effects on emerging market economies.
- The first strategy consists of returning to the pre-Covid-19 mode of loose fiscal policy and accommodating monetary policy. In the short-term this strategy will lead to faster global economic growth as long as in the U.S. the difference between the interest rate on public debt and the growth rate is negative. This strategy may entail a growing tail risk triggered by a future reversal of r-g, inducing a deeper future sudden stop crises and instability of Emerging Markets.
- The second strategy entails a reallocation of U.S. fiscal spending from fighting Covid-19’s medical and economic challenges towards physical, medical and social infrastructures which could provide a boost to future growth. With a lag, following the resumption of robust growth, increasing taxes and reaching a primary surplus may stabilize the U.S. and the global economy.
Such a trajectory may solidify the viability and credibility of the U.S. dollar as a global anchor, stabilizing thereby Emerging Markets economies and global growth.
Post COVID-19 Exit Strategies and Emerging Markets Economic Challenges
Authors: Joshua Aizenman, Hiro Ito
From: University of Southern California, Portland State University
