IMF Working Papers

Unintended Consequences of U. S. Monetary Policy Shocks: Dutch Disease and Capital Flow Measures in Emerging Markets and Developing Economies

By Juan Yepez

August 6, 2021

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Juan Yepez. Unintended Consequences of U. S. Monetary Policy Shocks: Dutch Disease and Capital Flow Measures in Emerging Markets and Developing Economies, (USA: International Monetary Fund, 2021) accessed November 4, 2024

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Summary

Dutch disease is often referred as a situation in which large and sustained foreign currency inflows lead to a contraction of the tradable sector by giving rise to a real appreciation of the home currency. This paper documents that this syndrome has been witnessed by many emerging markets and developing economies (EMDEs) as a result of surges in capital inflows driven by accommodative U. S. monetary policy. In a sample of 25 EMDEs from 2000-17, U. S. monetary policy shocks coincided with episodes of currency appreciation and a contraction in tradable output in these economies. The paper also shows empirically that the use of capital flow measures (CFMs) has been a common policy response in several EMDEs to U.S. monetary policy shocks. Against this background, the paper presents a two sector small open economy augmented with a learning-by-doing (LBD) mechanism in the tradable sector to rationalize these empirical findings. A welfare analysis provides a rationale for the use of CFMs as a second-best policy when agents do not internalize the LBD externality of costly resource misallocation as a result of greater capital inflows. However, the adequate calibration of CFMs and the quantification of the LBD externality represent important implementation challenges.

Subject: Balance of payments, Capital inflows, Dutch disease, Economic theory, Exchange rate arrangements, Exchange rates, External debt, Foreign exchange

Keywords: Capital inflows, Dutch disease, Dutch disease effect, EMDEs monetary policy framework, Emerging markets and developing economies, Exchange rate arrangements, Exchange rates, Global, LBD externality, Monetary policy shock

Publication Details

  • Pages:

    32

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

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  • Series:

    Working Paper No. 2021/209

  • Stock No:

    WPIEA2021209

  • ISBN:

    9781513589749

  • ISSN:

    1018-5941