Policy transmissions, external imbalances, and their impacts: Cross-country evidence from BRICS

- Dynamic interactions of policies and imbalances as well as their impacts are examined for BRICS countries.
- A dynamic panel VAR spillover framework considers the transmissions of both fiscal and monetary policies.
- Policy shocks are orthogonalized to assess the impacts on external balances and real economic performance.
- New cross-country evidence has been provided regarding the “twin deficits” hypothesis and the “price puzzle”.
- The role of exchange rates is examined in overall external positions and BRICS-US bilateral trade balances.

This paper provides an empirical exploration of the interaction between fiscal policy, monetary policy, exchange rates, and external balances as well as their impacts on real economic growth and inflation for the BRICS countries. A panel VAR model is employed to assess the dynamic relationships. Our results generally confirm the significant impacts of a monetary shock on real economic activity but the effect of fiscal policy appears to be much weaker from the cross-country perspective. We do not find evidence supporting the “twin deficits” hypothesis but the positive interaction between inflation and interest rates - the “price puzzle” - is documented. When bilateral exchange rates and trade deficits (vis-à-vis the US) are used, we find that the BRICS-US bilateral trade balances do not react considerably to currency depreciation shocks, indicating that exchange rates may not play a critical role in the adjustment of large trade deficits for the U.S.