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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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    Cited by:

    1. Stijn Claessens & M Ayhan Kose, 2018. "Frontiers of macrofinancial linkages," BIS Papers, Bank for International Settlements, number 95.
    2. Wee Chian Koh & Shu Yu, 2021. "A Decade After the 2009 Global Recession: Macroeconomic Developments," Journal of International Commerce, Economics and Policy (JICEP), World Scientific Publishing Co. Pte. Ltd., vol. 12(02), pages 1-24, June.
    3. 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.
    4. Kose, M. Ayhan & Arteta, Carlos & Stocker, Marc & Taskin, Temel, 2016. "Negative Interest Rate Policies: Sources and Implications," CEPR Discussion Papers 11433, C.E.P.R. Discussion Papers.
    5. Kose,Ayhan & Lakatos,Csilla & Ohnsorge,Franziska Lieselotte & Stocker,Marc, 2017. "The global role of the U.S. economy: linkages, policies and spillovers," Policy Research Working Paper Series 7962, The World Bank.
    6. M. Ayhan Kose & Naotaka Sugawara & Marco E. Terrones, 2020. "Global Recessions," Working Papers 162, Peruvian Economic Association.
    7. J. Scott Davis, 2016. "Economic fundamentals and monetary policy autonomy," Globalization Institute Working Papers 267, Federal Reserve Bank of Dallas.
    8. Jonathan Scott Davis, 2017. "External debt and monetary policy autonomy," Revista ESPE - Ensayos sobre Política Económica, Banco de la Republica de Colombia, vol. 35(82), pages 53-63, April.
    9. Ha, Jongrim & Kose, Ayhan M. & Ohnsorge, Franziska, 2022. "From Low to High Inflation: Implications for Emerging Market and Developing Economies," MPRA Paper 112596, University Library of Munich, Germany.
    10. Albertazzi, Ugo & Barbiero, Francesca & Marqués-Ibáñez, David & Popov, Alexander & Rodriguez d’Acri, Costanza & Vlassopoulos, Thomas, 2020. "Monetary policy and bank stability: the analytical toolbox reviewed," Working Paper Series 2377, European Central Bank.
    11. repec:bdr:ensayo:v:35:y:2017:i:82:p:96-105 is not listed on IDEAS
    12. Frankel, Jeffrey, 2016. "Globalization and Chinese Growth: Ends of Trends?," Working Paper Series 16-029, Harvard University, John F. Kennedy School of Government.
    13. Marfatia, Hardik A., 2020. "Investors’ risk perceptions in the US and global stock market integration," Research in International Business and Finance, Elsevier, vol. 52(C).
    14. Jongrim Ha & M. Ayhan Kose & Franziska Ohnsorge, 2022. "Global Stagflation," Koç University-TUSIAD Economic Research Forum Working Papers 2204, Koc University-TUSIAD Economic Research Forum.
    15. Stijn Claessens & M. Ayhan Kose, 2017. "Asset prices and macroeconomic outcomes: A survey," CAMA Working Papers 2017-76, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    16. 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.
    17. Koh,Wee Chian & Yu,Shu, 2020. "A Decade after the 2009 Global Recession : Macroeconomic and Financial Sector Policies," Policy Research Working Paper Series 9289, The World Bank.
    18. World Bank Group, 2016. "Commodity Markets Outlook, January 2016," World Bank Publications, The World Bank, number 23680.
    19. Prayudhi Azwar & Rod Tyers, 2016. "Post-GFC external shocks and Indonesian economic performance," CAMA Working Papers 2016-58, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    20. Agur, Itai & Chan, Melissa & Goswami, Mangal & Sharma, Sunil, 2019. "On international integration of emerging sovereign bond markets," Emerging Markets Review, Elsevier, vol. 38(C), pages 347-363.
    21. Ruch,Franz Ulrich, 2020. "Prospects, Risks, and Vulnerabilities in Emerging and Developing Economies : Lessons from the Past Decade," Policy Research Working Paper Series 9181, The World Bank.

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    More about this item

    Keywords

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

    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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