Contrary to historical episodes, the 2022–2023 tightening of US monetary policy has not yet triggered financial crisis in emerging markets. Why is this time different? To answer this question, we analyze the current situation through the lens of historical evidence. In emerging markets, the financial channel–based transmission of US policy historically led to more adverse outcomes compared to advanced economies, where the trade channel fails to smooth out these negative effects. When the Federal Reserve increases interest rates, global investors tend to shed risky assets in response to the tightening global financial conditions, affecting emerging markets more severely due to their lower credit ratings and higher risk profiles. This time around, the escape from emerging market assets and the increase in risk spreads have been limited. We document that the historical experience of higher risk spreads and capital outflows can be largely explained by the lack of credible monetary policies and dollar-denominated debt. The improvement in monetary policy frameworks combined with reduced levels of dollar-denominated debt have helped emerging markets weather the recent Federal Reserve hikes.
Authors
- Acknowledgements & Disclosure
- The authors thank Jose Ignacio Cristi Le-Fort, Mariana Sans for their outstanding research assistance, and Hudson Hinshaw and Omer Faruk Akbal for their superb help with the data. The views expressed and arguments employed in this paper are solely those of the authors and do not necessarily reflect the official views of the IMF and OECD, or its member countries. Any errors or omissions are the responsibility of the authors. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
- DOI
- https://doi.org/10.3386/w32329
- Published in
- United States of America
