The Potential Impact of the U.S. Federal Reserve’s Monetary Policy Normalization on Emerging Asia

In response to the global financial crisis of 2008-2009, which threatened to paralyze the global financial system and world economy, the U.S. Federal Reserve embarked on an unprecedented monetary expansion to support financial stability and economic growth. In response to improving economic conditions, the Fed has begun to normalize monetary policy since December 2015. In addition to gradually raising benchmark interest rates, which had reached virtually zero, the Fed will unwind the huge amounts of debt securities it had acquired to keep down long-term interest rates. There are widespread concerns in emerging Asia and other emerging markets that the Fed’s interest rate hikes and balance sheet unwinding will have serious repercussions for financial stability. In this paper, we attempt to analyze the effect of the Fed’s monetary policy normalization on emerging Asia. Our analysis indicates that the overall impact of normalization on the region’s financial stability is likely to be manageable and relatively limited in the short run. However, beyond the short run, the Fed’s policies are likely to herald a tightening of global liquidity conditions. Therefore, it is in emerging Asia’s interest to strengthen its financial conditions and remain vigilant.