Dominant Currency Shocks and Foreign Exchange Pressure in the Periphery

The spillover effects of strong dollar and euro, two dominant currencies, on emerging market economies (the periphery) are examined. This paper empirically studies the dominant currency shocks on foreign exchange (FX) constraint, economic growth, external debt, and inflation. Com-paring the dollar shock to the euro and commodity price shocks and employing pooled mean group estimates and panel VAR across regimes of trade invoicing, this paper shows that bilateral depreci-ation can worsen FX constraint and decrease growth in the periphery, failing to achieve the con-ventional macroeconomic adjustments of a competitive currency depreciation. A strong dollar re-duces external debt, but a strong euro has the opposite effect, implying circumvention of the ‘origi-nal sin.’ An FX-constraint shock emanating from the periphery appreciates the US dollar, affirm-ing dollar’s safe-haven status. These findings have implications for balance of payments and ex-change rate policy management