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Brazil in the 21st century: How to escape the high real interest trap?

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The hope that lower real interest rates and higher growth would follow the floatation of the currency was in large measure frustrated. Two international liquidity crises, caused by the reversal of capital flows, hit in 2001 and 2002. These crises were associated with higher interest rates, lower economic activity and higher inflation. Therefore, the name exchange-rate stagflation seems to characterize the essence of the phenomenon. A stylized model, due to Caballero and Krishnamurthy [2002], was used to explain the events. The main characteristic of the model is that domestic investment depends on the aggregate international liquidity of the economy, which is a limiting factor. During a liquidity crisis, the amount of liquidity is reduced, and the economy falls in recession. Neither the fiscal authority nor the monetary authority can reflate the economy by increasing government expenditures or the money supply. The bulk of the difficulties Brazil is currently facing derives from the uncertainty associated with the course of the future economic policy to be followed by the new administration, and to the sustainability of the public debt. To avert a painful default, real interest rates must fall and sustained growth must resume. To increase the chances of success, several policy measures are suggested: · To increase the exportability of the economy; · To increase the fiscal effort, in order to help dispel the doubts over the sustainability of the public debt; · To increase the credibility of the monetary authority, by conferring instrument independence to the Brazilian Central Bank; and · To resume the debt management efforts to lengthen the debt profile while reducing the indexation to the exchange rate and to the Selic short term rate, by making larger user of inflation-linked bonds. When and if the current international liquidity crisis is overcome, the above measures will help Brazil to lower the real interest rates and achieve sustained growth.

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  • Márcio G. P. Garcia, 2002. "Brazil in the 21st century: How to escape the high real interest trap?," Textos para discussão 466, Department of Economics PUC-Rio (Brazil).
    • Handle: RePEc:rio:texdis:466
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    1. Márcio Gomes Pinto Garcia, 2002. "Public debt management, monetary policy and financial institutions," Textos para discussão 464, Department of Economics PUC-Rio (Brazil).
    2. Garcia, Marcio G. P. & Barcinski, Alexandre, 1998. "Capital Flows to Brazil in the Nineties: Macroeconomic Aspects and the Effectiveness of Capital Controls," The Quarterly Review of Economics and Finance, Elsevier, vol. 38(3, Part 1), pages 319-357.
    3. 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.
    4. Olivier Jean Blanchard & Stanley Fischer, 1989. "Lectures on Macroeconomics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262022834, December.
    5. Shoven, John B. & Bernheim, B. Douglas (ed.), 1991. "National Saving and Economic Performance," National Bureau of Economic Research Books, University of Chicago Press, edition 1, number 9780226044040, December.
    6. Chinn, Menzie & Frankel, Jeffrey, 1994. "Patterns in Exchange Rate Forecasts for Twenty-five Currencies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(4), pages 759-770, November.
    7. Dionísio Dias Carneiro & André Monteiro D´Almeida Monteiro & Thomas Wu, 2002. "Mecanismos não-lineares de repasse cambial para o IPCA," Textos para discussão 462, Department of Economics PUC-Rio (Brazil).
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    1. Why are real interest rates in Brazil so high?
      by Tyler Cowen in Marginal Revolution on 2011-04-13 14:28:57

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    1. Marcelo de Paiva Abreu, 2003. "The political economy of economic integration in the Americas: Latin American interests," Textos para discussão 468, Department of Economics PUC-Rio (Brazil).

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