Overcoming the Fear of Free Falling: Monetary Policy Graduation in Emerging Markets
26 Pages Posted: 22 Jun 2012
Date Written: June 2012
Developing countries have typically pursued procyclical macroeconomic policies, which tend to amplify the underlying business cycle (the "when-it-rains-it-pours" phenomenon). There is, however, evidence to suggest that about a third of developing countries have shifted from procyclical to countercyclical fiscal policy over the last decade. We show that the same is true of monetary policy: around 35 percent of developing countries have become countercyclical over the last decade. We provide evidence that links procyclical monetary policy in developing countries to what we refer as the "fear of free falling;" that is, the need to raise interest rates in bad times to defend the domestic currency.
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