| Abstract: | This paper examines the hypothesis that the boom in dollar credit in emerging market economies (EMEs) is associated with an excessively low interest rate in the US. For this purpose, we use a multivariate correlated unobserved component model that allows for correlation between shocks to dollar credit, cross‐border interest rate gaps—measured as the difference between emerging market interest rate and the US interest rate, and dollar index both in the short run and in the long run. In addition, it also provides us a quantitative estimate of the permanent and transitory movements in dollar credit in EMEs, interest rate gaps and dollar index. The results from this model do suggest that a temporary increase in interest rate gaps and decline in the dollar index are associated with a temporary increase in the dollar credit in EMEs with a very high degree of correlation. The estimate of the cyclical component of the dollar credit in EMEs from our model captures the recent boom and bust in this market and compares favourably to alternative trend–cycle decomposition methods. |
