Global Flights-to-Safety and Macroeconomic Adjustment in Emerging Markets

Ahmed, Rashad (2020): Global Flights-to-Safety and Macroeconomic Adjustment in Emerging Markets.

Abstract

Financial market imperfections point toward large macroeconomic costs associated with 'flights-to-safety' in the absence of policy intervention. I investigate this implication empirically by developing a measure of global flights-to-safety and modelling their impact on emerging markets. Defined as joint tail realizations across developed market risky and safe asset returns, large flights-to-safety map to unexpected tail events and shape future world commodity prices, interest rates and U.S. Dollar fluctuations. In emerging markets, a global flight-to-safety induces a sharp rise in sovereign risk and exchange market pressure followed by a protracted drop in economic activity. These effects are substantially larger than those of U.S. monetary policy shocks and domestic financial shocks. Heterogeneity in adjustment patterns across countries suggest financial disruption as a key transmission channel but also a role for policy intervention: The impact of flights-to-safety on economic activity is amplified in countries realizing sharper adjustment in financial conditions, four times larger in emerging markets with U.S. exchange traded funds, and mitigated through 'leaning against the wind' with international reserves.

• Item Type: MPRA Paper
• Language: English
• Keywords: Tail Risk, Risk-off, Risk Sentiment, Contagion, International Reserves, Sovereign Risk, Financial Stability, Capital Flows, Macroprudential Policy
• Subjects: E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy; F - International Economics > F3 - International Finance > F30 - General; F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance > F44 - International Business Cycles; F - International Economics > F6 - Economic Impacts of Globalization > F60 - General; G - Financial Economics > G1 - General Financial Markets > G15 - International Financial Markets

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