In this section I assess EMEs’ resilience to external shocks by discussing the ways and extents of external shocks are transmitted to domestic economies of emerging markets. The first transmission way of external shocks is the trade channel. In recent decades EMEs have increased their share of global exports and recorded strong growth in inter-regional and intraregional trade among emerging markets. As a result, EMEs currently make up around one-fifth of the world’s total trade. In addition, they have diversified their production and exports. Although increased trade openness of EMEs magnifies the potential impact of external shocks on these economies, there are also positive developments such as strengthened product and regional diversity providing a degree of mitigation. Similar arguments can be made for the second transmission channel, namely funding channel: increased external liabilities but well diversified sources together with significantly lengthened maturities. But there is a negative development worth mentioning is that capital flows are mostly by driven by the unconventional  7  Hausmann, Ricardo and Ugo Panizza (2013), On the determinants of Original Sin: An empirical investigation, Journal of International Money and Finance, Volume 22(7), Pages 957–990. Hausmann, Ricardo and Ugo Panizza (2011), Redemption or Abstinence? Original Sin, Currency Mismatches and Counter Cyclical Policies in the New Millennium, Journal of Globalization & Development, Volume 2(1), Pages 1–35. 4  BIS central bankers’ speeches  policies of major central banks drive capital flows and they have become highly volatile since the GFC.
Prospects for weaker growth and lower inflation imply a lower interest rate than presented in the interest rate projection from our previous forecast in December. There is also a risk that the global downturn will be deeper and more prolonged than expected. If this proves to be the case, growth in the Norwegian economy will not pick up as quickly and inflation will fall more sharply than we currently assume. The objective of avoiding a pronounced downturn indicates in isolation that the interest rate should be rapidly reduced to a low level. On the other hand, we have already made substantial reductions in the key policy rate. With a low interest rate, households may save less and the turnaround may occur more rapidly than we assume. This indicates in isolation that changes in the interest rate should be gradual or that further interest rate cuts should be put on hold. Overall, the outlook and balance of risks suggest that the key policy rate should be gradually reduced further to a level of around 1 per cent in the second half of 2009. This is about 1 percentage point lower than in Norges Bank’s forecast from 17 December last year. With the low interest rate added to government fiscal measures, our analysis indicates that growth in the economy will be positive from the second half of this year. Growth will be driven by a rise in private consumption as a result of a low key policy rate, growth in real wages and higher government transfers.