Flights-to-Safety and Macroeconomic Adjustment in Emerging Markets : The Role of U.S. Monetary Policy

Sudden, asymmetric shifts in investor sentiment known as 'flights-to-safety' typically emanate from center economies but propagate globally. In the absence of policy intervention, these financial shocks can spill over and destabilize macroeconomic conditions in many countries. This paper explores these issues systematically over the 2000-2019 period, implementing a two-stage approach for measuring flights-to-safety originating in developed markets. First, tail realizations in asset returns are recovered from an asymmetric time-varying volatility model. Second, sign restrictions are imposed across assets to identify flights-to-safety from general changes in financial conditions. Estimates from a multi-country VAR show that flights-to-safety exhibit significant spillovers to emerging markets, inducing a rise in sovereign risk premia and exchange market pressure, and a drop in economic activity. Expansionary U.S. monetary policy shocks reduce these spillovers, suggesting that U.S. policy responses play an outsized role in shaping financial stability abroad