How U.S. Financial Decisions Impact Global Markets

By Ned Blanchard ’24, Gerard Marretta ’24, Benny Simoes ’24, Matt Belcher ’24

Contributing writers

What if a choice made in one nation had the power to ripple across borders and impact markets and livelihoods all across the world? That is precisely the authority that the U.S. Federal Reserve, our nation’s central bank, possesses. Its recent actions to combat inflation have impacted economies domestically and internationally. The United States is largest financial player in the world. As people from or attending school in the U.S., we often are only concerned with how financial decisions will affect us domestically. In reality, the effects of U.S. monetary policy decisions are felt well beyond our border, with significant ramifications across the globe, particularly on emerging market economies. This piece looks at how important choices in the U.S., like changing interest rates or increasing money supply, can affect countries all over the world. It’s not just about big numbers and complicated economics. Understanding this can help you chat about world news more confidently, maybe even at your next family dinner when everyone is talking about money and markets.

There are two basic approaches to understand how U.S. economic policies affect emerging markets: through the trade channel and the finance channel. Depending on U.S. demand, the trade channel influences the amount of exports from emerging markets to the U.S. The amount of money available for investment is influenced by the financial channel. The global availability of money as well as investors’ propensity to take on risk are impacted by fluctuations in U.S. interest rates. This in turn affects borrowing costs and currency exchange risk, as well as the pricing of assets like stocks, government bonds and real estate.

Back in 2020, when the world was grappling with the COVID-19 pandemic, the Federal Reserve slashed interest rates almost to the floor and pumped money into the economy. This was all in a bid to keep the economy humming along. For a while, it worked, and things started looking up. All of this was done to maintain a strong economy. It worked for a time, and things began to improve. But as we are all aware, there can be drawbacks to having too much of a good thing. Inflation in the United States began to surge in 2021, reaching levels not seen in more than 40 years because of the economy being overheated like a vehicle engine in need of coolant. Imagine a world where prices are rising so quickly that the cost of your daily coffee is rising. The Federal Reserve tried to cool things down by raising interest rates aggressively.

 For the rest of the globe, this is where it gets heated. As money began to migrate back to the U.S. in quest of better returns, nations like Argentina, Brazil and Turkey—which were already struggling economically—felt the pinch. ‘Capital outflows,’ or the flight of money out of a nation more quickly than fans out of a stadium following a game, resulted from this. What was the outcome? Their currencies plummeted, increasing the cost of imports and complicating financial planning. However, not everyone had the same response. For instance, Mexico defied the pattern. As a result of certain astute fiscal policy decisions and investor confidence in Mexico’s future, the peso strengthened. Lucky them!

The story of sovereign credit spreads, which is a fancy way of saying how much more interest other nations pay on their loans than the United States, thickens the storyline. Though these rates should rise in tandem with increased risk, other nations, such as Turkey and Colombia, experienced a tightening of their spreads, indicating that investors may be starting to view them as opportunistic economies.

As for these emerging economies, stock markets? They did, however, dance to the beat of the U.S. rate increases. Predictably, stocks fell when interest rates increased. The inflation in these countries also followed American example. As U.S. interest rates rose, inflation dropped from Chile to the Philippines, supporting the theory that the decisions made by the U.S. have ramifications far beyond its borders.

The Federal Reserve controls the movement of money in the world. They can impact the amount of money businesses can borrow and invest by making decisions on interest rates or pumping money into the economy. Think of the Federal Reserve as a DJ at a party, the global economy, and when he plays fast-paced music, it is like cutting interest rates and pumping money into the economy. When the DJ changes the music to a slower pace, raising interest rates, some people may not like dancing as much, leading to a decline in the party energy levels. Similarly, when the U.S. raises interest rates, it can make it more expensive for businesses to borrow money to grow and invest. As a result, GDP growth rates in countries like Chile, Turkey, Malaysia, South Africa, Argentina and the Philippines, have started to decline due to this slow pace of music choice by the DJ. So, to easily under the impacts of the Federal Reserve on Emerging economies, it can help to think of it as a party, the DJ’s music choices (U.S. monetary policy) can significantly impact how the party (global economy) unfolds.

As citizens of the world, it is important for us to understand how and why certain mechanisms occur within the global economy and how decisions made by the Fed can have long-term and short-term effects. Through actions like increasing money supply and interest rates, the Fed can significantly impact borrowing costs, currency values and even the prices of assets like stocks and real estate. This greatly impacts emerging market economies, causing currencies to fluctuate, stock markets to react and inflation rates to shift. Understanding the impact of the Fed’s policies is crucial, as they greatly impact our lives. Even if you don’t realize it! So, just like a DJ at a party, pay attention to the beat of the music to understand how it can sway the global economy!