Estimating the Spillover Effects of U.S. Monetary Policy Normalization on Emerging Market Economies

Abstract

This paper examines the potential impact of US monetary policy normalization and its associated spillover effects on emerging market economies. Through the use of a Bayesian vector-autoregressive (VAR) model, this paper identifies and estimates a normalization shock within the United States, defined to represent an exogenous change to future tapering expectations. The policy normalization shock is estimated to have significant macroeconomic and financial impacts, particularly on consumer prices and industrial output within the domestic model. The posterior median of the identified normalization shock is then used as an exogenous input within a Bayesian panel VAR model, constructed for a sample of 13 emerging market economies. An estimation of the dynamic response of stock market indices, nominal effective exchange rates, sovereign bond yields, and capital flows, to the identified normalization shock is then conducted across these emerging economies. The defined shock responses demonstrate significant effects including an exchange rate depreciation, a decrease in stock market prices, and an increase in long-term bond yields. An assessment of heterogeneity in emerging economy response is further conducted to identify inherent structural factors that determine particular responses to normalization, with the ‘BRICS’ nations exhibiting stronger and more extended effects in comparison to the broader group of emerging economies.