Tailwinds and Headwinds: How Does Growth in the BRICs Affect Inflation in the G-7?

In this paper, we analyze the impact of a persistent productivity increase in a set of countries—which we think of as the economies of Brazil, Russia, India, and China (BRIC)—on inflation in their trading partners, the Group of Seven (G-7). In particular, we want to understand the conditions under which this shock can lead to tailwinds or headwinds in the economies of trading partners. We build a three-country dynamic stochastic general equilibrium (DSGE) model in which there are two oil-importing countries (home and foreign) and one oilexporting country. In our benchmark calibration, we find that the tailwind effect, lowering inflation in the home economy, dominates the headwind effect. However, if the oil demand elasticity is low (equal to the empirical short-run estimate) or the labor market is flexible, inflation at home rises in the subsequent periods as a result of the foreign productivity shock.