Monetary policy reaction function: A Bayesian analysis for the BRICS

by Farah Waheed, Abdul Rashid, Asma Basit, Lubna Maroof

This study estimates the monetary policy reaction function (MPRF) in a Dynamic Stochastic General Equilibrium (DSGE) framework using Bayesian analysis for the emerging economies. DSGE models are suitable for the policy analysis because of their simplicity and prominent role of forward-looking variables. This is a pioneer study investigating the combined effects of credit spreads, fiscal imbalances, and monetary autonomy on interest rates for BRICS member countries. Using real data for the period 1970–2021, the posterior estimates confirm that both credit spread and fiscal imbalance significantly contribute to fluctuations in output, inflation, and interest rates in all the sample economies. The estimates show that fluctuations in the inflation rate are due to supply shocks. The empirical estimates also reveal that fiscal imbalances shock significantly affect output in Brazil, India, and South Africa, whereas, based on real data inflation and interest rate are significantly affected by fiscal imbalance shocks in China and South Africa. Yet, the findings suggest that the effects of various shocks on output and interest rates vary across countries.