Divergent EME Responses to Global and Domestic Monetary Policy Shocks

Abstract

We assess the effect of tighter monetary policy in the U.S. and emerging market economies (EMEs) on EMEs using a panel factor-augmented VAR model. We find that a U.S. policy rate hike outstrips an equivalent domestic rate hike in its impacts on EMEs. In addition, EMEs show divergent policy responses and their macro-financial responses differ depending upon their economic fundamentals in the face of tighter U.S. policy. In particular, we find that high-inflation than low-inflation EMEs are more susceptible to the shock stemming from a U.S. federal funds rate hike.

Addressing Spillovers from Prolonged U.S. Monetary Policy Easing

“…See, for example,Rey (2013),Obstfeld (2015),Passari and Rey (2015),Choi et al (2017),Arregui et al (2018), andAvdjiev et al (2019).2 SeeFarhi and Werning (2016),Ghosh et al (2016),Korinek and Sandri (2016),Arce et al (2019), Cavallino (2019,Adrian et al. (2020),Basu et al (2020), and Fanelli and Straub (2020).3 For example,Ghosh et al (2017), Mano and Sgherri (2020), andPasricha (2020) show that various policies respond to capital flow shocks or financial stability concerns, by estimating policy reaction functions in emerging market economies.…”