| Abstract: |
We study how the financial conditions in the Center Economies [the U.S.,
Japan, and the Euro area] impact other countries over the period 1986 through
2015. Our methodology relies upon a two-step approach. We focus on five
possible linkages between the center economies (CEs) and the non-Center
economics, or peripheral economies (PHs), and investigate the strength of
these linkages. For each of the five linkages, we first regress a financial
variable of the PHs on financial variables of the CEs while controlling for
global factors. Next, we examine the determinants of sensitivity to the CEs as
a function of country-specific macroeconomic conditions and policies,
including the exchange rate regime, currency weights, monetary, trade and
financial linkages with the CEs, the levels of institutional development, and
international reserves. Extending our previous work (Aizenman et al. (2016)),
we devote special attention to the impact of currency weights in the implicit
currency basket, balance sheet exposure, and currency composition of external
debt. We find that for both policy interest rates and the real exchange rate
(REER), the link with the CEs has been pervasive for developing and emerging
market economies in the last two decades, although the movements of policy
interest rates are found to be more sensitive to global financial shocks
around the time of the emerging markets’ crises in the late 1990s and early
2000s, and since 2008. When we estimate the determinants of the extent of
connectivity, we find evidence that the weights of major currencies, external
debt, and currency compositions of debt are significant factors. More
specifically, having a higher weight on the dollar (or the euro) makes the
response of a financial variable such as the REER and exchange market pressure
in the PHs more sensitive to a change in key variables in the U.S. (or the
euro area) such as policy interest rates and the REER. While having more
exposure to external debt would have similar impacts on the financial linkages
between the CEs and the PHs, the currency composition of international debt
securities does matter. Economies more reliant on dollar-denominated debt
issuance tend to be more vulnerable to shocks emanating from the U.S. |