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

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 12, 2024

Disclaimer: IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

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:

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DOI:

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Issue:

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Series:

Working Paper No. 2021/209
Stock No:

WPIEA2021209
ISBN:

9781513589749
ISSN:

1018-5941

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