Editor’s Note: Claude Lopez is Director of International Finance and Macroeconomics Research at the Milken Institute. The opinions expressed in this commentary are her own.
All eyes will be on the Federal Reserve later this month as it considers lowering interest rates for the first time since the global financial crisis of 2008. As the world’s most powerful central bank, the Fed should take into consideration how changing interest rates may affect emerging nations’ economies.
Yes, the Fed’s first responsibility is to keep the US economy healthy. Likewise, the other globally-influential central banks — a group that includes the European Central Bank, the Bank of Japan and the Bank of England — must first look to the welfare of the economies they serve. But because policy changes by these important central banks affect the exchange rates of currencies and determine how money flows through international markets, their actions can have global repercussions.
When one of the major central banks raises interest rates, it has an impact on their currency’s exchange rate. The incremented increases of the US interest rate between December 2015 and December 2018 contributed to making the dollar more attractive to investors. As investors buy dollars, it appreciates relative to other currencies. For emerging economies with dollar-denominated debt, the stronger dollar makes it harder to pay off the loans. The increased debt burden may grow into a potential threat to domestic growth and financial stability.
The four major central banks maintained historically-low interest rates for more than a decade to give their domestic economies a boost. And for the most part, these policies succeeded.
Yet we have seen that subsequent interest rate increases have sparked incipient crises in several countries, including less-developed members of the G20 such as Argentina and Turkey.
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Numerous factors are at play in Turkey’s slide, including domestic political tensions, US tariffs and ill-advised government actions. But it is clear that, by maintaining historically-low interest rates for a long period, the Fed facilitated Turkey’s accumulation of a high external debt.
While most Americans felt little, if any, pain as the Fed continued to raise rates last year, each quarter-percent increment pushed Turkey closer to the brink because of the large holdings of dollar-denominated debt accumulated when rates were low. The challenge for Turkey is to reimburse its