Collateral Damage: Dollar Strength and Emerging Markets’ Growth
IMF Working Papers, July 29, 2015
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Bibliographic details
- Authors: Pablo F Druck, Nicolas E Magud, Rodrigo Mariscal
- Published: July 29, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498323338.001
Summary
- Historically, stronger growth in the U.S. increases growth in emerging markets.
- U.S. dollar appreciation (depreciation) cycles—which are highly persistent—mitigate (amplify) the impact on real GDP growth in emerging markets.
- The main transmission channel is an income effect: as the dollar appreciates, commodity prices fall; weaker commodity prices depress domestic demand via lower real income; real GDP in emerging markets decelerates; and vice versa.
- These effects hold despite any potential expenditure-switching effect resulting from the relative (to the U.S. dollar) currency depreciation of emerging market economies.
- U.S. interest rates have a negative effect on emerging markets’ growth beyond the effects of the U.S. real exchange rate and real GDP growth.
- At the time of writing, emerging markets’ growth is expected to remain subdued reflecting, inter alia, the expected persistence of the strong dollar and the anticipated increased in the U.S. interest rates.
Key findings and mechanisms
- Dollar appreciation cycles are highly persistent and significantly alter the transmission of U.S. growth to emerging markets.
- Income-channel transmission:
- Dollar appreciation → commodity prices fall.
- Lower commodity prices → weaker domestic demand via lower real income in emerging markets.
- Result → deceleration in real GDP growth in emerging markets.
- Expenditure-switching channel:
- Any potential expenditure-switching effect from relative currency depreciation in emerging markets does not offset the income-channel effects.
- U.S. interest rates:
- Higher U.S. interest rates exert a negative effect on emerging markets’ growth that is not fully captured by movements in the U.S. real exchange rate or U.S. real GDP growth.
Policy implications and outlook
- Emerging markets’ growth prospects are adversely affected by persistent dollar strength and rising U.S. interest rates.
- Policy attention in emerging markets may be warranted to mitigate income-channel effects from commodity-price declines associated with a stronger dollar.