Asymmetric impacts of U.S. monetary policy on emerging markets: Contagion and macroeconomic determinants

Do fluctuations in U.S. short-term interest rates, both decreases and increases, have distinct effects on the monetary policies of emerging market economies (EMEs)? We use various empirical techniques to examine the responses of EMEs' monetary decisions across distinct phases of U.S. monetary policy (USMP). Our analysis uses data from 17 economies with inflation goals and predominantly flexible exchange rate systems from 2000 to 2020. Our findings underscore the asymmetric contagion effects of USMP. Both U.S. short-term rates decrease and increase, demonstrating a significant contagion effect in the near term. Conversely, U.S. long-term rates influence the domestic rates of EMEs when tighter, with no observed contagion during easing. Moreover, EMEs with higher GDP growth rates and trade balances demonstrate lower susceptibility to contagion. Conversely, in confirmation of the global financial cycle theory, an increase in capital inflows and surging stock market indices is correlated with heightened contagion. Our study suggests that EMEs should closely monitor and react to USMP changes to maintain financial stability and recommends that U.S. policymakers consider the international impacts of its policies, advocating for increased dialogue and collaboration.