Working Paper: NBER ID: w31004
Authors: Maurice Obstfeld; Haonan Zhou
Abstract: The U.S. dollar’s nominal effective exchange rate closely tracks global financial conditions, which themselves show a cyclical pattern. Over that cycle, world asset prices, leverage, and capital flows move in concert with global growth, especially influencing the fortunes of emerging and developing economies (EMDEs). This paper documents that dollar appreciation shocks predict economic downturns in EMDEs and highlights policies countries could implement to dampen the effects of dollar fluctuations. Dollar appreciation shocks themselves are highly correlated not just with tighter U.S. monetary policies, but also with measures of U.S. domestic and international dollar funding stress that themselves reflect global investors’ risk appetite. After the initial market panic and upward dollar spike at the start of the COVID-19 pandemic, the dollar fell as global financial conditions eased; but the higher inflation that followed has induced central banks everywhere to tighten monetary policies more recently. The dollar has strengthened considerably since mid-2021 and a contractionary phase of the global financial cycle is now under way. Owing to increases in public- and business-sector debts during the pandemic, a strong dollar, higher interest rates, and slower economic growth will be challenging for EMDEs.
Keywords: No keywords provided
JEL Codes: E58; F31; F41; F44; O11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dollar appreciation shocks (F31) | Declines in output (E23) |
| Dollar appreciation shocks (F31) | Declines in consumption (D12) |
| Dollar appreciation shocks (F31) | Declines in investment (G31) |
| Dollar appreciation shocks (F31) | Declines in government spending (H59) |
| US monetary policy changes (E52) | Dollar movements (F31) |
| Dollar appreciation shocks (F31) | Depreciation of local currencies (F31) |
| Dollar appreciation shocks (F31) | Fall in terms of trade (F14) |
| Dollar appreciation shocks (F31) | Decline in domestic credit (F65) |