Monetary spillovers and real exchange rate misalignments in emerging markets

Abstract

PurposeAfter the adoption of unconventional monetary policies (UMPs) in advanced economies (AEs) there were many studies of monetary spillovers to asset prices in emerging market economies (EMEs) but the extent of contribution of EMEs and AEs, respectively, in real exchange rate (RER) misalignments has not been addressed. This paper addresses the gap in a cross-country panel set-up with country specific controls.Design/methodology/approachFixed effects, pooled mean group (Pesaran et al., 1999) and common correlated effects (Pesaran, 2006) estimations are used to examine the relationship. Multiway clustering is taken into account to ensure robust statistical inferences.FindingsRobust evidence is found for significant monetary spillovers over 1998–2017 in the form of RER overvaluation of EMEs against AEs, especially through the portfolio rebalancing channel. EME RER against the US saw significantly more overvaluation in UMP years indicating greater role of the US in monetary spillovers. However, in the long-run monetary neutrality holds. EMEs did pursue mercantilist and precautionary policies that undervalued their RERs. Precautionary undervaluation is more evident with bilateral EME US RER.Research limitations/implicationsIt may be useful for large EMEs to monitor the impact of foreign portfolio flows on short-run deviations in RER. Export diversification reduces EME mercantilist motives against the US. That AE monetary policy significantly appreciates EME RER has implications for future policy cooperation between EMEs and AEs.Originality/valueTo the best of the author's knowledge such a comparative analysis between AE and EME policy variables on RER misalignment has not been done previously.

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