Experimenting with Unconventional Monetary Policy: Quantitative Easing in Emerging Markets During Covid-19

Abstract

The Covid-19 Global Health Pandemic introduced a number of economic challenges to countries around the world. Notably, most policymakers implemented greater fiscal spending and monetary stimulus. For the first time, 15 emerging market economies experimented quantitative easing. Most were not constrained by the zero-lower-bound condition, and the degree of financial depth, central bank independence, and central bank transparency varied significantly. This research yields three critical findings. First, emerging markets experienced declines in capital flows and depreciation pressure stemming from quantitative easing. Second, quantitative easing in advanced economies had a more sizable and significant effect than domestic policies. Finally, the degree of financial development and central bank independence are key drivers in how quantitative easing impacts exchange rates specifically. More developed financial systems and greater central bank independence correspond to dampening the effect of quantitative easing on exchange rates.

KEYWORDS:

• Unconventional monetary policy
• emerging markets
• exchange rates
• foreign capital flows
• Covid-19

MATHEMATICS SUBJECT CLASSIFICATIONS:

• E52
• F31
• F42

Disclosure Statement

No potential conflict of interest was reported by the author(s).

Notes

1 Not shown is the relationship between central bank independence and the short-term interest rate, which in fact was not significant. Results available upon request.

2 The dataset begins in 2015 to allow for the focus of the research to be on the experimentation with quantitative easing by emerging market economies. Before 2015, advanced economies had been utilizing quantitative easing measures since 2008 to offset the effects of the Global Financial Crisis. This period includes the use of unconventional monetary policy by the Federal Reserve, European Central Bank, Bank of England, Bank of Japan, and others. By 2014, the Federal Reserve began to roll back its quantitative easing policies, which yielded the ‘taper tantrum’ and negatively impacted foreign flows to many emerging market economies. Since the focus of this paper is not on the international transmission of monetary shocks from advanced to emerging markets, the data used begins in 2015.

3 Specifically, the Wu-Xia shadow rate has been used to track QE in the US, calculated to account for the zero-lower-bound condition. However, such measures do not exist for emerging markets, partly because many are not at the zero-lower-bound.