During 1999-2007, the international balance sheets of emerging economies grew stronger through a combination of current account surpluses, a shift from debt funding to equity funding, and the stockpiling of liquid foreign reserves. This risk-mitigating strategy improved the international financial standing of many emerging economies and helped these economies withstand the 2008- 2009 global financial crisis.

However, a combination of domestic and external factors has led to a partial reversal of this strategy, with some emerging economies accumulating significant external debt since 2010. Previewed by the May 2013 “taper tantrum,” there has been considerable speculation that a tightening of dollar-funding conditions and a macroeconomic slowdown in emerging economies may result in financial instability in some emerging economies. 

The risk of a global shock to international funding conditions is extensively documented. In view of the central role of the dollar in international funding markets, global financial conditions are significantly influenced by the stance of U.S. monetary policy. In particular, it is now widely accepted that the federal funds rate plays an important role in determining the availability of dollar funding.

  • Şebnem Kalemli-Özcan is a Neil Moskowitz Endowed Professor of Economics at the University of Maryland, College Park. She is a research associate at the National Bureau of Economic Research and a research fellow at the Center for Economic Policy Research.