Working Paper: NBER ID: w30458
Authors: Pierre De Leo; Gita Gopinath; Ebnem Kalemlizcan
Abstract: We document that emerging market central banks adhere to Taylor-type rules and lower their policy rates when economic activity slows down, including as a response to U.S. monetary policy tightening. This suggests a countercyclical monetary policy stance. However, in contrast to advanced economies, short-term market rates do not move in tandem with policy rates. Market rates, if anything, tend to increase during recessions. We present evidence that this disconnect between policy rates and market rates can be significantly explained by fluctuations in dollar funding premia that get transmitted into local market rates through the banking sector that relies on foreign funding. Our findings shed light on the challenges to transmission and effectiveness of monetary policy in emerging economies.
Keywords: Monetary Policy; Emerging Economies; Global Financial Conditions
JEL Codes: E0; F0; F3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| US monetary policy tightening (E52) | increased short-term market rates (E43) |
| US monetary policy tightening (E52) | lower policy rates (E43) |
| lower policy rates (E43) | increased short-term market rates (E43) |
| reliance on international funding sources (F35) | passthrough of policy rates to market rates (E43) |
| disconnect between policy rates and short-term market rates (E43) | contractionary force on economic activity (E49) |