Monetary responses to external shocks in emerging market economies: the role of financial vulnerabilities

Mikael Juselius and Dora Xia

BIS Quarterly Review, 2026

Abstract: We examine how reliance on external funding and foreign exchange (FX) market depth shape monetary policy responses to external shocks in emerging market economies (EMEs) with floating exchange rate arrangements. Using a panel of EMEs, we document that central banks in economies with both high external foreign currency debt and shallow FX markets move their policy rates in step with US monetary policy surprises. Notably, these countries show smaller exchange rate moves compared with other countries, consistent with the policy actions dampening FX fluctuations. Other economies, including those with larger external local currency debt, do not display these patterns. We also find that EMEs with shallow FX markets tend to deploy FX intervention following US monetary policy surprises.

JEL-codes: E58 F41 F42 (search for similar items in EconPapers)
Date: 2026
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