Research

We develop a new framework to study how trade policy and central bank actions interact in a world connected through trade and finance. The model captures how tariffs and other trade barriers affect inflation, employment, output, and the exchange rate—particularly when countries are linked through complex input–output networks. Our findings show that tariffs operate as both supply and demand shocks, generating broad ripple effects across the global economy. The magnitude and direction of these effects depend critically on how central banks respond. Using the model, we replicate key features of the U.S. experience during the 2018 tariff hikes, including slower growth, rising inflation, and a stronger U.S. dollar. We apply our framework to ""Liberation Day"" tariffs as well. Importantly, we also find that even tariff threats—announcements that are later reversed—can negatively affect the economy.

We developed a global economic model to understand how disruptions in one part of the world—such as low vaccination rates in emerging economies during the COVID-19 pandemic—can affect advanced economies. When developing countries were forced to impose lockdowns due to uncontrolled infections, the global economy experienced ripple effects: shortages of critical inputs, higher import prices, and weaker external demand for exports from advanced economies. Our model quantifies the economic costs of these disruptions for wealthier countries and shows that the magnitude of the impact depends heavily on how interconnected industries are through global supply chains. The key insight is clear: investing in vaccine access for lower-income countries is not just a humanitarian imperative—it is also a sound economic strategy for advanced economies seeking to safeguard their own growth and stability.

We introduce a new measure of currency risk for emerging markets, the UIP premium, and highlight five key insights into its cross-sectional and time-series properties. We derive the UIP premium from survey data on exchange rate expectations and show that it captures a substantial local risk factor, as evidenced by: (1) The UIP premium for emerging markets is consistently positive, higher, and more volatile than the UIP premium for advanced economies; (2) A significant portion of cross-sectional and time-series variation in the UIP premium is driven by local risk factors; (3) The interest rate differential component of the UIP premium is more volatile and strongly correlated with local risk factors; (4) Local and global risk factors influence exchange rate expectations, which closely align with actual exchange rate movements; (5) The local risk factor is associated with country-specific policy shocks, where such policy uncertainty can predict persistent expectations of depreciations.

Using comprehensive administrative data on Chilean firms, we examine whether credit lines and government-backed credit guarantees mitigated the impact of the large sudden stop event during the pandemic—the abrupt withdrawal of international capital. Our analysis employs a regression discontinuity design to demonstrate that firms eligible for these programs increased their borrowing from domestic lenders at a relatively lower cost. By reducing the cost of domestic currency debt relative to foreign currency debt, these policies effectively lowered the relative cost of domestic capital in the short term. This reduction in borrowing costs is conditional on selection effects at both the firm and bank levels, where only policy-eligible firms benefit from the lower credit costs from the same lender that non-eligible firms also borrow from. An open economy model with heterogeneous firms and financial frictions helps explain our findings: government interventions eased the higher cost of capital during the sudden stop by relaxing firms’ domestic collateral constraints, which in turn reduced domestic financial intermediaries’ risk aversion and boosted the supply of domestic credit in the face of shrinking international capital flows.

We built a global economic model to understand what caused inflation during and after the pandemic. It shows that both country-specific and worldwide shocks—like supply disruptions and shifts in demand—spread through global trade and production networks. Even if labor shortages happened unevenly, they pushed up costs across many sectors, leading to broad-based inflation. Countries with flexible exchange rates were better at handling these shocks, limiting inflation spillovers. Overall, it was the mix of sector-specific supply problems and global demand surges that best explains why inflation rose in so many places at once.

We find that central banks in emerging economies with floating exchange rates follow the Taylor-rule and lower policy rates during economic slowdowns, indicating a countercyclical monetary policy stance. However, unlike in advanced economies, short-term market rates in many emerging economies do not always move together with policy rates; while policy rates are pro-cyclical, market rates are often counter-cyclical. This short-rate disconnect can be explained by external factors. Emerging economies where banks hold significant external liabilities, and face high external premiums, experience an incomplete pass-through of policy rate changes into market rates and a reduction in the efficacy of monetary policy.

Unlike in the past, the recent U.S. interest rate hikes in 2022–2023 haven’t caused a financial crisis in emerging markets. Historically, these countries were hit hard when the Federal Reserve raised rates, as investors pulled out and borrowing costs soared. But this time is different. Emerging markets have improved their monetary policies and reduced their reliance on U.S. dollar debt, making them more resilient. As a result, there’s been less capital flight and smaller increases in risk premiums than in previous episodes. These results imply that the way FED hikes transmit to the rest of the world is through higher risk premiums and countries can reduce their own premia with increased monetary policy credibility.

We study the effects of financial frictions on firm exit when firms face large liquidity shocks. We develop a simple model of firm cost-minimization, where firms’ borrowing capacity to smooth temporary shocks to liquidity is limited. In this framework, firm exit arises from the interaction between this financial friction and fluctuations in cash flow due to aggregate and sectoral changes in demand conditions, as well as more traditional shocks to productivity. To evaluate the implications of our model, we use firm level data on small and medium sized enterprises (SMEs) in 11 European countries. We confirm that our framework is consistent with official failure rates in 2017-2019, a period characterized by standard business cycle fluctuations. To capture a large liquidity shock, we apply our framework to the COVID-19 crisis. We find that, absent government support, SME failure rates would have increased by 6.01 percentage points, putting 3.1% of employment at risk. Our results also show that in the presence of financial frictions and in the absence of government support, the firms failing due to COVID have similar productivity and growth to firms that survive COVID.

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 study why inflation rose in the Euro Area during the COVID-19 pandemic and how it compared to what happened in the U.S. between 2020 and 2021. We find that the shift in consumer spending—from services to goods—played a big role in driving inflation, especially because global supply chains amplified the effects. Labor shortages in specific sectors made the problem worse, leading to higher inflation than if the economy had only faced changes in demand. Interestingly, global supply disruptions and foreign shocks mattered more for inflation in Europe than domestic spending did. Also, even though demand for goods was strong, trade didn’t respond as much as it did during the 2008–09 crisis, partly due to supply bottlenecks. The overall takeaway is that inflation would have been much lower without these supply-side issues, even if governments had tried to stimulate demand.

This article studies the transmission of the Global Financial Cycle (GFC) to domestic credit market conditions in a large emerging market, Turkey, over 2003–13. We use administrative data covering the universe of corporate credit transactions matched to bank balance sheets to document four facts: (1) an easing in global financial conditions leads to lower borrowing costs and an increase in local lending; (2) domestic banks more exposed to international capital markets transmit the GFC locally; (3) the fall in local currency borrowing costs is larger than foreign currency borrowing costs due to the co-movement of the uncovered interest rate parity (UIP) premium with the GFC over time; (4) data on posted collateral for new loan issuances show that collateral constraints do not relax during the boom phase of the GFC.