Working Paper: NBER ID: w26297
Authors: Ebnem Kalemli-Ozcan
Abstract: I show that monetary policy divergence vis-a-vis the U.S. has larger spillover effects in emerging markets than advanced economies. The monetary policy of the U.S. affects domestic credit costs in other countries through its effect on global investors’ risk perceptions. Capital flows in and out of emerging market economies are particularly sensitive to fluctuations in such risk perceptions and have a direct effect on local credit spreads. Domestic monetary policy is ineffective in mitigating this effect as the pass-through of policy rate changes into short-term interest rates is imperfect. This disconnect between short rates and monetary policy rates is explained by changes in risk perceptions. A key policy implication of my findings is that emerging markets’ monetary policy actions designed to limit exchange rate volatility can be counterproductive.
Keywords: Monetary Policy; Emerging Markets; Risk Spillovers; Capital Flows
JEL Codes: E0; F0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| U.S. monetary policy divergence (E49) | larger spillover effects in emerging markets (F69) |
| contractionary U.S. monetary policy (E52) | capital flows shift from low-interest-rate countries to the U.S. (F32) |
| capital flows shift from low-interest-rate countries to the U.S. (F32) | exacerbating credit costs in EMEs (F65) |
| imperfect passthrough of U.S. monetary policy (E49) | domestic monetary policy actions in EMEs are ineffective (E69) |
| changing risk premia (G40) | disconnect between policy rates and domestic credit costs (E43) |
| 10 percentage point increase in policy rate differentials (E43) | significant increases in capital flows to EMEs (F32) |
| international risk spillovers (F65) | undermining effectiveness of monetary policy in EMEs (E49) |