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The Coming U.S. Interest Rate Tightening Cycle: Smooth Sailing or Stormy Waters?

Author

Listed:
  • Carlos Arteta

    () (World Bank, Development Prospects Group)

  • M. Ayhan Kose

    () (World Bank, Development Prospects Group)

  • Franziska Ohnsorge

    () (World Bank, Development Prospects Group)

  • Marc Stocke

    () (World Bank, Development Prospects Group)

Abstract

The U.S. Federal Reserve (Fed) is expected to start raising policy interest rates in the near term and thus commence a tightening cycle for the first time in nearly a decade. The taper tantrum episode of May‐June 2013 is a reminder that even a long anticipated change in Fed policies can trigger substantial financial market volatility in Emerging and Frontier Market Economies (EFEs). This paper provides a comprehensive analysis of the potential implications of the Fed tightening cycle for EFEs. We report three major findings: First, since the tightening cycle will take place in the context of a robust U.S. economy, it could be associated with positive real spillovers to EFEs. Second, while the tightening cycle is expected to proceed smoothly, there are risks of a disorderly adjustment of market expectations. The sudden realization of these risks could lead to a significant decline in EFE capital flows. For example, a 100 basis point jump in U.S. long‐term yields could temporarily reduce aggregate capital flows to EFEs by up to 2.2 percentage point of their combined GDP. Third, in anticipation of the risks surrounding the tightening cycle, EFEs should prioritize monetary and fiscal policies that reduce vulnerabilities and implement structural policy measures that improve growth prospects.

Suggested Citation

  • Carlos Arteta & M. Ayhan Kose & Franziska Ohnsorge & Marc Stocke, 2015. "The Coming U.S. Interest Rate Tightening Cycle: Smooth Sailing or Stormy Waters?," Koç University-TUSIAD Economic Research Forum Working Papers 1522, Koc University-TUSIAD Economic Research Forum.
  • Handle: RePEc:koc:wpaper:1522
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    File URL: http://eaf.ku.edu.tr/sites/eaf.ku.edu.tr/files/erf_wp_1522.pdf
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    References listed on IDEAS

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    Cited by:

    1. Raju Huidrom & M. Ayhan Kose & Franziska L. Ohnsorge, 2018. "Challenges of Fiscal Policy in Emerging and Developing Economies," Emerging Markets Finance and Trade, Taylor & Francis Journals, vol. 54(9), pages 1927-1945, July.
    2. Davis, Scott, 2016. "Economic fundamentals and monetary policy autonomy," Globalization and Monetary Policy Institute Working Paper 267, Federal Reserve Bank of Dallas.
    3. Frankel, Jeffrey, 2016. "Globalization and Chinese Growth: Ends of Trends?," Working Paper Series 16-029, Harvard University, John F. Kennedy School of Government.
    4. repec:wsi:jicepx:v:08:y:2017:i:01:n:s179399331750003x is not listed on IDEAS
    5. Franziska Ohnsorge & Shu Yu, 2017. "Recent Credit Surge in Historical Context," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 8(01), pages 1-22, February.

    More about this item

    Keywords

    Federal Reserve; liftoff; tightening; interest rates; monetary policy; emerging markets; frontier markets; capital flows; sudden stops; crises.;

    JEL classification:

    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • F30 - International Economics - - International Finance - - - General
    • F65 - International Economics - - Economic Impacts of Globalization - - - Finance
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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