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Country spreads and emerging countries

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  • Mart´in Uribe
  • Vivian Z. Yue
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    Abstract

    A number of studies have stressed the role of movements in U.S. interest rates and country spreads in driving business cycles in emerging market economies. At the same time, country spreads have been found to respond to changes in both the U.S. interest rate and domestic conditions in emerging markets. These intricate interrelationships leave open a number of fundamental questions: Do country spreads drive business cycles in emerging countries or vice versa, or both? Do U.S. interest rates affect emerging countries directly or primarily through their effect on country spreads? This paper addresses these and other related questions using a methodology that combines empirical and theoretical elements. The main findings are: (1) U.S. interest rate shocks explain about 20 percent of movements in aggregate activity in emerging market economies at business-cycle frequency. (2) Country spread shocks explain about 12 percent of business-cycle movements in emerging economies. (3) About 60 percent of movements in country spreads are explained by country-spread shocks. (4) In response to an increase in U.S. interest rates, country spreads first fall and then display a large, delayed overshooting; (5) U.S.-interest-rate shocks affect domestic variables mostly through their effects on country spreads. (6) The fact that country spreads respond to business conditions in emerging economies significantly exacerbates aggregate volatility in these countries. (7) The U.S.-interest-rate shocks and country-spread shocks identified in this paper are plausible in the sense that they imply similar business cycles in the context of an empirical VAR model as they do in the context of a theoretical dynamic general equilibrium model of an emerging market economy.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of San Francisco in its series Working Paper Series with number 2004-32.

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    Date of creation: 2003
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    Handle: RePEc:fip:fedfwp:2004-32

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    Related research

    Keywords: Interest rates ; Business cycles ; Economic development;

    References

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    1. Lawrence J. Christiano & Martin Eichenbaum & Charles L. Evans, 2001. "Nominal rigidities and the dynamic effects of a shock to monetary policy," Working Paper Series WP-01-08, Federal Reserve Bank of Chicago.
    2. Richard Cantor & Frank Packer, 1996. "Determinants and impact of sovereign credit ratings," Economic Policy Review, Federal Reserve Bank of New York, issue Oct, pages 37-53.
    3. Pablo A. Neumeyer & Fabrizio Perri, 2004. "Business cycles in emerging economies: the role of interest rates," Staff Report 335, Federal Reserve Bank of Minneapolis.
    4. Abel, Andrew B, 1990. "Asset Prices under Habit Formation and Catching Up with the Joneses," American Economic Review, American Economic Association, vol. 80(2), pages 38-42, May.
    5. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
    6. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
    7. Barry Eichengreen & Ashoka Mody, 1998. "What Explains Changing Spreads on Emerging-Market Debt: Fundamentals or Market Sentiment?," NBER Working Papers 6408, National Bureau of Economic Research, Inc.
    8. Uribe, Martin, 2002. "The price-consumption puzzle of currency pegs," Journal of Monetary Economics, Elsevier, vol. 49(3), pages 533-569, April.
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    Cited by:
    1. Yue, Vivian Z., 2010. "Sovereign default and debt renegotiation," Journal of International Economics, Elsevier, vol. 80(2), pages 176-187, March.
    2. Garima Vasishtha & Taimur Baig & Manmohan S. Kumar & Edda Zoli, 2006. "Fiscal and Monetary Nexus in Emerging Market Economies," IMF Working Papers 06/184, International Monetary Fund.
    3. Bonilla, Eugenio Diaz, 2008. "Global macroeconomic developments and poverty:," IFPRI discussion papers 766, International Food Policy Research Institute (IFPRI).
    4. Vivian Z. Yue & Samir Jahjah, 2004. "Exchange Rate Policy and Sovereign Bond Spreads in Developing Countries," IMF Working Papers 04/210, International Monetary Fund.

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