Federal Reserve Board analysis finds more-vulnerable emerging markets outperformed model predictions during 2022-23 U.S. tightening

The Federal Reserve Board published a research note assessing how less-vulnerable and more-vulnerable emerging market economies performed during the 2022-23 U.S. monetary tightening cycle against a model calibrated to capture cross-border spillovers. It finds that more-vulnerable EMEs fared better than the model would have predicted in both financial market and growth outcomes, while less-vulnerable EMEs did slightly better than predicted on financial conditions but substantially worse on growth. Using a two-country New Keynesian framework and a vulnerability index based on external balances, reserves, debt, inflation and credit conditions, the note concludes that the 2022-23 tightening was driven more by adverse monetary shocks than by positive U.S. growth shocks, although both contributed. Under that inferred mix, exchange-rate depreciation in less-vulnerable EMEs was broadly in line with the model, but corporate spreads were lower than predicted. In more-vulnerable EMEs, financial stress was much milder than the model implied and GDP remained considerably above the model-implied path. The note says the gap between predictions and outcomes may reflect factors outside the United States, including commodity prices and China's growth prospects, or improvements in policy frameworks in more-vulnerable EMEs that are not yet captured by the vulnerability index.