BPEA | Fall 2023

Global transmission of Fed hikes

The role of policy credibility and balance sheets

Globe on a wave of dollar bills
Editor's note:

The paper summarized here is part of the fall 2023 edition of the Brookings Papers on Economic Activity, the leading conference series and journal in economics for timely, cutting-edge research about real-world policy issues. Research findings are presented in a clear and accessible style to maximize their impact on economic understanding and policymaking. The editors are Brookings Nonresident Senior Fellows Janice Eberly and Jón Steinsson.

See the fall 2023 BPEA event page to watch paper presentations and read summaries of all the papers from this edition. Submit a proposal to present at a future BPEA conference here.

Rapid Federal Reserve interest rate increases last year and earlier this year have not, at least so far, triggered financial crises in emerging markets and developing economies—in stark contrast to spillovers from U.S. interest rate hikes in the 1980s and 1990s, notes a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on September 28.

The reason, according to the paper, “Global Transmission of Fed Hikes: The Role of Policy Credibility and Balance Sheets,” is that many emerging market countries have strengthened the credibility of their monetary policies; reduced the foreign debt of their non-financial corporations, governments, and household; and made sure their banks protected their balance sheets from a steep drop in the value of local currencies.

“We show that, this time around … the improvement in monetary policy frameworks … combined with reduced levels of dollar-denominated debt helped emerging markets to weather the … Fed hikes,” write the authors, Şebnem Kalemli-Özcan of the University of Maryland and Filiz Ünsal of the Organisation for Economic Co-operation and Development.

U.S. inflation surged to a 40-year high of 9.1% in June 2022. To combat it, the Fed raised its short-term interest rate target from near zero at the start of 2022 to a range of 5-1/4-to-5-1/2%. Annual inflation has since fallen below 4%.

In the past, when the Federal Reserve raised U.S. rates, central banks in emerging-market countries with high levels of dollar debt confronted an unpleasant trade-off. If they failed to match the Fed rate hikes, the value of their currencies would fall (since dollar-denominated assets would earn a higher rate than local-currency assets). And businesses and households that must swap local currencies for dollars to pay off their debts would face a crunch. However, when central banks matched the Fed hikes, it often triggered an economic downturn by slowing domestic investment and spending.

According to the paper, if the central banks had had more policy credibility for keeping inflation low, which also would have helped limit the impact on the value of their currencies, they could have avoided mimicking the Fed’s policy path and set monetary policy based on local economic conditions.

That, in fact, is what has happened most recently, the paper suggests. An index of monetary policy credibility in 50 countries, constructed by Ünsal and the co-authors of a separate paper, shows emerging market policy credibility rose significantly from 2007 to 2021. The index evaluated monetary policy independence and accountability, policy and operational strategies, and communications.

Likely not coincidentally, with increased policy credibility, the 25 largest emerging market and developing economy countries have all beaten the International Monetary Fund’s 2022 growth forecasts for them.

“Emerging market central banks in the 2020s have learned the lessons of the ‘80s and ‘90s. They learned the importance not just of inflation targeting but of doing what they say they will do. The biggest Fed hike in decades didn’t cause a crisis because they improved their credibility, reducing global investors’ need to charge emerging markets sharply higher interest rates,” Kalemli-Özcan said in an interview with The Brookings Institution.

The Fed’s most recent rate increases did tighten global financial conditions, slowing growth somewhat.

“It is not that there is zero effect, but it is short of a crisis,” Kalemli-Özcan said.


Kalemli-Özcan, Şebnem and Filiz Ünsal. 2023. “Global transmission of Fed hikes: The role of policy credibility and balance sheets.” BPEA Conference Draft, Fall.


  • Acknowledgements and disclosures

    Şebnem Kalemli-Özcan holds unpaid advisory positions with the New York Federal Reserve Bank and the Bank of International Settlements. The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Other than the aforementioned, the authors are not currently an officer, director, or board member of any organization with a financial or political interest in this article. The Organization for Economic Cooperation and Development, Ünsal’s employer, had the right to review this work prior to publication.

    David Skidmore authored the summary language for this paper. Chris Miller assisted with data visualization.