NCPA - National Center for Policy Analysis

Why Foreign Economies Watch U.S. Interest Rates

January 11, 2000

Fluctuations in U.S. interest rates do have an impact on foreign countries -- although the impact on some is greater than on others. Just as higher rates tone down economic activity in the U.S., they can have a similar effect on countries that have borrowed U.S. dollars at U.S. rates.

  • In 1998, the Federal Reserve cut interest rates three times primarily to ensure an ample flow of funds during global financial crises.
  • Economists say the economies of Latin American countries are closely tied to the U.S. dollar and are more vulnerable to U.S. rate rises -- and recoveries from the 1998 turmoil have been weakest there.
  • European and Asian countries would be much less affected by future U.S. rate increases -- Europe because countries are much more closely tied to the euro, and Asia because many countries there still have restrictions on borrowing.
  • Anticipated hikes in U.S. rates might even help Japan's economy -- since they would weaken the yen and make the country's exports cheaper.

Rates aside, what would happen to the rest of the world if U.S. equities fell? Experts say that's a tougher question to answer and they point out that asset bubbles may be forming overseas as well -- for example, in Japan.

The Organization for Economic Cooperation and Development projects that a 20 percent slump in global stock markets would shave about 1 percent off U.S. gross domestic product. The effect of such a drop would be smaller in Japan, Europe and Canada, the organization believes.

Source: Claire Mencke, "As U.S. Interest Rates Head Higher, Are Overseas Economies at Risk?" Investor's Business Daily, January 11, 2000.


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