Spillovers of U.S. Fiscal Challenges: The Global Impact of U.S. Fiscal Dominance Concerns on Interest Rates in Emerging and Developed Markets

This study examines the international spillovers of U.S. inflationary spells and fiscal concerns on policy interest rates in Emerging Market Economies (EMEs) and Developed Economies (DEs). Previous research has focused on fiscal concerns in domestic environments, overlooking cross-border impacts. Using data from EMEs and DEs, we construct a novel index of fiscal dominance concerns through Principal Components Analysis to capture international fiscal dynamics. The results are confirmed by robustness analysis and show that greater U.S. fiscal challenges affect negatively the policy rates in both EMEs and DEs, with a greater impact observed in EMEs. Moreover, a low degree of financial repression in EMEs is associated with more significant spillover effects from greater U.S. fiscal challenges. Our findings offer insights into the complex interplay between financial repression, central bank independence, and global market integration in shaping a country's resilience to international financial influences.