Asymmetric effects of fiscal balance on monetary variables: evidence from large emerging economies

This paper investigates the nonlinear impacts of fiscal balances on interest rates, exchange rates and inflation in large emerging economies. The paper applies asymmetric cointegration modelling in a nonlinear autoregression distributed lag framework to discriminate the effects of negative and positive changes in the fiscal balance on monetary variables in BRICs. This approach is advantageous to the analysis of dynamic asymmetric relationships in both the long and short run regardless of whether variables are a mix of I(0) and I(1). A distinctive feature of this study is that the main result indicates that monetary variables react differently to negative and positive changes in fiscal balances over the long run for Brazil and India, but not for the others. Since interest rates and inflation are more sensitive to worsening fiscal position, fiscal consolidation is an essential criterion for the effectiveness of monetary policy in the economies characterised with large fiscal imbalance and debt stocks, such as Brazil and India. The implementation of expansionary fiscal policy should be reconsidered carefully in economies with a better fiscal performance like China and Russia, since the persistently rising budget deficits eventually countered the effectiveness of monetary policy by keeping market interest rates and inflation at high levels. This paper provides evidence in favour of the dominant role of fiscal policy to stabilise monetary variables in large emerging economies. We also highlight the importance of long-term fiscal sustainability to improve the monetary policy effectiveness.