Asymmetric Effects of the Fiscal Balance on Monetary Variables : Evidence from Emerging Economies

Purpose: This paper aims to investigate the nonlinear impacts of the fiscal balance on interest rates, exchange rates and in inflation in emerging economies, based on the model of sovereign risk premium.Methodology: The paper applies asymmetric cointegration modeling in a nonlinear autoregression distributed lag (ARDL) framework (Shin et al., 2014) to discriminate the effects of negative and positive changes in the fiscal balance on monetary variables in Brazil, Russia, India, and China (BRICs), using quarterly observations from around 2000 to 2016. Findings: The divergence in empirical evidence of asymmetric effects among BRICs is a distinct feature of this paper. Our results underline that monetary variables react di erently to negative and positive changes in the fiscal balance over the long run for Brazil and India, but not for China and Russia.Practical implications: Since monetary variables are more sensitive to worsening fiscal position in periods when budget de ficits tend to rise, fiscal consolidation is an essential criterion for the effectiveness of monetary policy in emerging economies characterized with large fiscal imbalance and debt stocks, such as Brazil and India. The implementation of expansionary fiscal policy should be reconsidered carefully even in economies with a better fi scal performance like China and Russia, as the persistently rising budget de ficits eventually counter the effectiveness of monetary policy by keeping market interest rates and inflation at high levels.Originality/Value: This paper provides evidence in favour of the dominant role of fi scal policy to stabilise interest rates, exchange rates, and inflation in emerging economies with high default risks stemming from chronically high fi scal de cits. We also highlight the importance of long-term fiscal sustainability to improve the effectiveness of monetary policy