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Inflation Targeting and Debt: Lessons from Brazil

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  • Carlo A. Favero
  • Francesco Giavazzi

Abstract

Studying the recent experience of Brazil the paper explains how default risk is at the centre of the mechanism through which an emerging market central bank that targets inflation might lose control of inflation--in other words of the mechanism through which the economy might move from a regime of 'monetary dominance' to one of 'fiscal dominance'. The literature, from Sargent and Wallace (1981) to the modern fiscal theory of the price level has discussed how an unsustainable fiscal policy may hinder the effectiveness of monetary policy, to the point that an increase in interest rates can have a perverse effect on inflation. We show that the presence of default risk reinforces the possibility that a vicious circle might arise, making the fiscal constraint on monetary policy more stringent.

Suggested Citation

  • Carlo A. Favero & Francesco Giavazzi, 2004. "Inflation Targeting and Debt: Lessons from Brazil," NBER Working Papers 10390, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:10390
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    References listed on IDEAS

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    1. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
    2. Uribe, Martin, 2006. "A fiscal theory of sovereign risk," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 1857-1875, November.
    3. Thomas J. Sargent & Neil Wallace, 1984. "Some Unpleasant Monetarist Arithmetic," Palgrave Macmillan Books, in: Brian Griffiths & Geoffrey E. Wood (ed.), Monetarism in the United Kingdom, pages 15-41, Palgrave Macmillan.
    4. Olivier Blanchard, 2004. "Fiscal Dominance and Inflation Targeting: Lessons from Brazil," NBER Working Papers 10389, National Bureau of Economic Research, Inc.
    5. Dirk Niepelt, 2004. "The Fiscal Myth of the Price Level," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 119(1), pages 277-300.
    6. Guillermo A. Calvo & Leonardo Leiderman & Carmen M. Reinhart, 1993. "Capital Inflows and Real Exchange Rate Appreciation in Latin America: The Role of External Factors," IMF Staff Papers, Palgrave Macmillan, vol. 40(1), pages 108-151, March.
    7. Carlo Ambrogio Favero & Francesco Giavazzi, "undated". "Why are Brazil´s Interest Rates so High?," Working Papers 224, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    8. Alexius, Annika, 2002. "Can Endogenous Monetary Policy Explain the Deviations from UIP," Working Paper Series 2002:17, Uppsala University, Department of Economics.
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    More about this item

    JEL classification:

    • E4 - Macroeconomics and Monetary Economics - - Money and Interest Rates
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook

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