Abstract
This paper describes major economic developments in Brazil in 1997. A number of issues were analyzed in the paper, including the slow progress being made in the negotiation of the fiscal adjustment programs with the states, the sustainability of the growing current account deficit, as well as the strength of the banking system following macroeconomic stabilization. The paper discusses the post-Real crisis in the states and the state adjustment programs being negotiated with the federal government. Privatization and the associated foreign direct investment flows are also described.
IV. The Transmission of Monetary Impulses in Brazil: Some Theoretical and Empirical Issues40
A. Introduction
91. There is a broad consensus that, at least in the short run, monetary policy actions have an impact on the behavior of real economic activity, namely on aggregate spending, production and employment. The monetary transmission mechanism has received a great deal of attention in the literature because for monetary policy to be effective, a central bank needs to have a clear understanding of the specific process and timing (including lags) by which monetary impulses are transmitted throughout the economy.
92. The monetary transmission mechanism can work through the channels of interest rates, the exchange rate, asset market prices (e.g., equity and real estate prices), and bank credit. In the early years of the debate about the monetary transmission mechanism the dominant view was that monetary policy operated mainly through the interest rate channel.41 With increasing globalization over the last two decades, including a higher degree of international financial capital mobility, and the onset of flexible exchange rates, greater attention has been given to the role of exchange rates in the monetary transmission mechanism.42 With international financial capital mobility, the exchange rate channel of monetary policy operates through the interest rate parity relationship.43 At the same time, greater attention has been paid to asset market prices, such as stock prices and other financial asset prices (including the term structure of interest rates), as important channels of monetary transmission.44 More recently, however, there has been a renewed interest in the monetary transmission mechanism, mainly because of a debate over the relative importance of bank credit in the process of monetary transmission.
93. The credit channel was suggested by Bernanke and Gertler (1995) and stresses the relative changes in macroeconomic variables (real and nominal) that result from the impact of central bank actions on the supply and demand of loans. However, as Bernanke and Gertler pointed out, the credit channel should not be viewed as a distinct and independent alternative to the traditional channels of monetary transmission such as interest rates, the exchange rate and other asset market prices, but rather a mechanism that includes a set of factors in the credit market that amplify and propagate the traditional channels of monetary transmission. In addition, the credit channel helps to explain the movements in real output that result from monetary impulses that alter the lending policy of financial institutions (including nonprice factors such as credit rationing) independently of movements in both interest rates and exchange rates. Accordingly, it is argued that the credit channel is well suited to explain the strength, timing and composition of the effects of monetary policy actions that are overlooked by the mainstream views of the transmission mechanism.
94. A general view from the studies of the monetary transmission mechanism is that, although there are close linkages between monetary policy actions and the behavior of the real economy, the precise nature and pattern of the relevant channels is difficult to pin down. Friedman and Schwartz (1963) pioneered the empirical analysis of the monetary transmission mechanism and presented evidence that there are close correlations between monetary aggregates and economic activity. Since then a number of empirical studies45 have confirmed their finding that monetary impulses are eventually followed by movements in real output that may last for two or more years. Nevertheless, there is no clear consensus about the relative importance of the channels through which monetary impulses are transmitted onto changes in real output. This chapter draws on the recent literature to delineate the main features of the process of monetary transmission in Brazil.
95. The task of understanding the transmission of monetary policy in Brazil is more difficult than in stable economies of industrial countries because Brazil’s economy has been undergoing deep structural and behavioral changes that have been associated with the ongoing process of macroeconomic stabilization under the Real Plan. Indeed, as stressed by Lopes (1997), when an economy moves from a period of high inflation to low inflation the nature of the monetary transmission mechanism changes as monetary policy gradually regains its effectiveness. For several years prior to the introduction of the Real Plan in mid-1994, there was chronic high inflation in Brazil and this led to the adoption of widespread indexation of both financial and real variables as hedge for inflation. In such an economy, monetary policy for the most part loses its ability to affect the real economy. Economic stabilization under the Real Plan, however, brought about a gradual removal of indexation, a fact which has contributed to the establishment of a favorable environment for the restoration of the effectiveness of monetary policy.
96. This chapter tries to trace the impact of monetary policy actions that eventually leads to changes in the real and nominal aggregates. More concretely, the chapter investigates how aggregate demand and real output in Brazil respond to changes in interest rates, exchange rates, and other relevant financial market prices. It also explores the role of credit conditions in the monetary transmission mechanism. The remaining sections of the chapter are structured as follows. The next section analyses and discusses the mechanism of transmission of monetary impulses in Brazil, comparing the period under high inflation with the recent period of economic stabilization. In addition, the section illustrates graphically the principal linkages underlying the mechanism of monetary transmission in Brazil. A particular focus is given to the effects of interest rates, exchange rates, and credit factors on aggregate real output. The last section outlines the main conclusions of the chapter.
B. Outline of the Monetary Transmission Mechanism in Brazil
97. The present analysis adopts an eclectic view of the monetary transmission mechanism in the sense that it considers the transmission process to operate through the combination of interest rates, exchange rate, and credit factors channels as opposed to the mainstream approaches that emphasize one or two of the relevant channels. These channels in turn influence aggregate spending and production.
98. Fundamentally, the central bank exercises its influence on interest rates, exchange rates and credit conditions through its control of liquidity conditions in the money market. The instruments used by the central bank to control liquidity are open market operations, reserve requirements and the discount window. At present, the central bank conducts monetary policy essentially by setting on a monthly basis minimum (TBC) and maximum (TBAN) overnight rates of interest for its lending and borrowing operations in the money market.46 In general, the overnight interest rate for transactions in the interbank market, the SELIC rate47 fluctuates between the TBC and the TBAN. The central bank exerts its direct influence on the SELIC rate by adjusting the amount of liquidity in the overnight interbank market. This induces financial institutions to bid more or less for overnight funds, thus pressing the SELIC rate to change up or down in order for the overnight interbank market to clear.48 In particular, when central bank actions create a shortage of liquidity in the overnight interbank market then, the SELIC rate will rise to a new level as financial institutions scramble for funds while, when central bank actions cause an excess of liquidity in the interbank market, the SELIC rate will drop as financial institutions make efforts to find alternative placements for their excess balances. In summary, the central bank can adjust the amount of liquidity available to financial institutions to induce them to alter the SELIC rate to a level that the central bank deems desirable.
99. Movements in the overnight interbank interest rate trigger a series of portfolio shifts among market participants that in turn affect the term structure of interest rates. The specific pattern of interest rates beyond the overnight horizon depends heavily on market expectations of the future path of overnight interest rates, which in turn rely on the perception of the market about the sustainability of the monetary policy stance.49 For example, suppose the SELIC rate rises in response to a central bank decision to tighten liquidity conditions to control incipient demand pressures in the economy. In such a situation, the reaction of longer term interest rates will depend largely on the amount of time market participants expects the new level of the SELIC rate to last. The longer the new level of the SELIC rate is expected to last the greater will be its impact on interest rates with maturities beyond overnight Thus, if the market felt that the demand pressures were only of a brief duration, it would not expect the new level of the SELIC rate to remain for a long time, thus resulting in only a limited increase, if any, in the rest of interest rates along the yield curve. Accordingly, the longer the maturity of securities, the weaker will be the impact of an increase in the SELIC rate. But, if instead the market interpreted the increase in the SELIC rate as the beginning of a period of high levels of interest rates in response to demand pressures that are perceived as long lasting, then the impact of an increase in the SELIC rate on longer term interest rates would be more pronounced.
100. An increase in the nominal interest rate combined with sticky prices or sluggish price adjustment, implies a higher real interest rate, at least temporarily. Over time, however, as wages and good prices adjust, the real interest rate will converge to a new equilibrium level. Thus, the slower the adjustment of prices is, the greater will be the increase in real interest rates. A higher interest rate would in turn lead to a reduction in aggregate demand via lower levels of business fixed investment, residential housing investment, consumer durable outlays and inventory investment, therefore causing aggregate output to fall. Over time, these changes are propagated and magnified by the induced multiplier and accelerator effects.50 This type of interest rate channel is characteristic of an economy that has achieved some degree of stability. In general, when an economy is suffering from high inflation, the interest rate channel is expected to be weak, in part because widespread indexation normally prevails. For this reason, we would expect the interest rate channel to be relatively weak prior to the introduction of the Real Plan in mid-1994, and to gradually regain its effectiveness in controlling spending as the economy stabilized successfully under the Real Plan.
101. In the case of the Brazilian economy, an informal analysis suggests that the interest rate channel was strong even during periods of high inflation. Real interest rates were generally high and extremely volatile during those periods, but as the economy stabilized after the Real Plan was introduced in 1994, they converged to low levels and their volatility declined sharply (Figure 15). There also would appear to be an inverse relation between real GDP with real interest rates with a quarter lag, both in the periods of high inflation and the recent period of stabilization under the Real Plan, although this would need to be confirmed by further empirical analysis (Figure 16).51 52 The apparent strength of the interest rate channel during high inflation may be an indication that despite the existence of widespread indexation of wages and financial prices before the Real Plan, there was some stickiness in wages and good prices that allowed the interest rate to be a channel of transmission of monetary policy. This could be explained in large part by the backward nature of the indexation schemes in place during hyperinflation.
Brazil: Changes in the General Price Index (IGP-DI) and Real Interest Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Monthly nominal interest rate (SELIC) adjusted to the general price index (IGP-DI).Brazil: Changes in the General Price Index (IGP-DI) and Real Interest Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Monthly nominal interest rate (SELIC) adjusted to the general price index (IGP-DI).Brazil: Changes in the General Price Index (IGP-DI) and Real Interest Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Monthly nominal interest rate (SELIC) adjusted to the general price index (IGP-DI).
Brazil: Growth in Real GDP and Changes in Interest Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Monthly nominal interest rate (SELIC) adjusted to IGP-DI (sign reversed).Brazil: Growth in Real GDP and Changes in Interest Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Monthly nominal interest rate (SELIC) adjusted to IGP-DI (sign reversed).Brazil: Growth in Real GDP and Changes in Interest Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Monthly nominal interest rate (SELIC) adjusted to IGP-DI (sign reversed).102. Since March 1995, the Central Bank of Brazil has exerted direct influence on the exchange rate through the establishment of an adjustable exchange rate band.53 In practice, the central bank announces periodically a wide exchange rate band which is changed about once a year, and induces a monthly depreciation of the real versus the U.S. dollar by moving a miniband (within the wider band) which is established through buying and selling auctions in the foreign exchange market several times a month. At present, the ceiling of the wider band is about 9 percent higher than the floor, while the width of the miniband, is generally kept below 1 percent. Within the miniband, exchange rates are determined by participants in the interbank market.
103. If the market feels that the level of the SELIC rate is inadequate,54 investors will be reluctant to hold reais at the current exchange rate. As a result they will be induced to channel their funds toward foreign currencies and other foreign-currency-denominated financial assets (with higher interest rates adjusted for expected exchange rate changes), thus putting pressure on the foreign exchange market. If the central bank is unwilling to meet the demand for foreign exchange and is reluctant to raise the SELIC rate further for fear of crowding out domestic investment, the exchange rate would come under pressure as investors move out of reais to avert or limit a potential loss from expected exchange rate movements. As soon as the exchange rate reaches the ceiling of the miniband, the central bank would be expected to change the miniband towards a more depreciated level.55 The impact of a movement in the SELIC rate on the exchange rate is also largely a function of market expectations regarding the likely duration of the new level of the SELIC rate. The longer the new level of the SELIC rate is expected to last, the stronger the effect will be on the exchange rate.
104. An immediate implication of this analysis is that when the central bank takes actions to influence interest rates it must also take into account the effects of its actions on exchange rates. Also, central bank actions to influence the exchange rate (by way of an autonomous change in the miniband) without the supporting demand management policies in place, may fail to achieve the desired results.
105. The mainstream views that link movements in exchange rates to aggregate demand and economic activity are straightforward. Exchange rate movements exert influence on aggregate demand and economic activity primarily by altering the competitiveness of domestic goods that are traded internationally. For example, a nominal depreciation of the real will raise the domestic price of tradables relative to the price of nontradables. To the extent that wages and prices are slow to adjust, a nominal depreciation of the real will result in a depreciation of the real in real terms. This will initiate a series of demand and supply responses that over time will result in higher exports and lower imports, hence bringing about an increase in economic activity. On the supply side, the relative increase in the prices of tradables, renders their production more profitable, thus inducing suppliers to produce more tradables.56 As with the interest rate, the strength of the supply responses of tradables will depend largely on the expected sustainability of the real depreciation of the currency. In this way, if the more depreciated level of the currency is perceived as permanent, the supply responses are likely to be stronger. Otherwise suppliers will be reluctant to expand their productive capacity.
106. On the demand side, the increase in the relative prices of tradables will shift domestic demand away from tradables towards nontradables, thus entailing a reduction of imports and an increase in the demand for nontradables. In addition, the depreciation of the real could make domestic tradables cheaper in world markets, as the increased profitability in local currency could induce suppliers to lower their export prices in foreign currency to gain market share. Therefore, in general, a positive correlation is expected to exist between exchange rates and aggregate demand. In the case of Brazil, it is interesting to consider whether there is any modification of the exchange rate channel in the transition from high inflation to low inflation. A casual observation of the Brazilian economy also reveals that the exchange rate channel may have been an influence both in high inflation and in the recent period of economic stabilization (Figures 17 and 18). Indeed, the real exchange rate fluctuated widely during high inflation periods, despite some implicit pegging of the nominal exchange rate to international price differentials. Over time, the changes in the real exchange rate would appear to have influenced the performance of net exports, which in turn may have brought about changes in the level of economic activity. In particular, the real depreciation (appreciation) of the real would appear to be positively related to real GDP growth with a one quarter lag, although again this would require further empirical work to confirm (Figures 19 and 20). In the aftermath of the introduction of the Real Plan, the currency appreciated significantly in real terms, bringing about an adverse turnaround in the performance of net exports.57 Therefore, it can be concluded that the effectiveness of the exchange rate channel was not modified significantly with the move of the Brazilian economy from periods of high inflation to low inflation.
Brazil: Inflation and Real Exchange Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and U.S. inflation.Brazil: Inflation and Real Exchange Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and U.S. inflation.Brazil: Inflation and Real Exchange Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and U.S. inflation.
Brazil: Inflation and Real Effective Exchange Rates
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and Brazil’s major trading partners’ inflation.Brazil: Inflation and Real Effective Exchange Rates
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and Brazil’s major trading partners’ inflation.Brazil: Inflation and Real Effective Exchange Rates
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and Brazil’s major trading partners’ inflation.
Brazil; Growth in Real GDP and Changes in Exchange Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and U.S. inflation.Brazil; Growth in Real GDP and Changes in Exchange Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and U.S. inflation.Brazil; Growth in Real GDP and Changes in Exchange Rates
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and U.S. inflation.
Brazil: Growth in Real GDP and Changes in Effective Exchange Rates
(quarterly growth rate, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and Brazil’s major trading partners’ inflation.Brazil: Growth in Real GDP and Changes in Effective Exchange Rates
(quarterly growth rate, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and Brazil’s major trading partners’ inflation.Brazil: Growth in Real GDP and Changes in Effective Exchange Rates
(quarterly growth rate, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Sources: Central Bank of Brazil and Information Notice System (IMF).1 Nominal exchange rate adjusted to domestic (IGP-DI) and Brazil’s major trading partners’ inflation.107. The responses of the economy to central bank policy actions cannot be explained exclusively in terms of interest rate and exchange rate effects. As highlighted in recent literature, the credit channel helps to explain the reaction of the economy to changes in monetary policy that is not induced by changes in interest rates or exchange rates. Fundamentally, the credit channel is relevant when central bank actions lead to changes in the conditions of lending and borrowing that are uncorrelated with movements in interest rates or exchange rates. As suggested by Bernanke and Gertler (1989) central bank actions exert influence on the conditions of lending and borrowing in credit markets through their effects on the external finance premium of borrowers, defined as the wedge between the cost of external financing from resources other than the borrowers’ (i.e., equity and/or debt issues) and the opportunity cost of internal financing (via retained earnings).58 In particular, the external finance premium could be viewed broadly as the spread that financial institutions charge for borrowing and lending operations (Lopes, 1997). Therefore, changes in the external finance premium are expected to have a significant impact on real spending and real output, mainly by amplifying the responses of the economy to central bank actions. In general, the credit channel literature considers that central bank actions influence the external finance premium through two possible mechanisms: the bank lending channel and the balance sheet channel (also referred to as the net worth effect).
108. According to the banking lending channel, monetary policy influences the external finance premium by influencing the availability of bank loans relative to other forms of credit. When the central bank tightens monetary policy, banks are compelled to reduce their supply of loans. Those borrowers that are dependent on bank loans will respond to the reduction in bank loans by looking for alternative sources of credit, hence incurring additional costs that are likely to increase the external finance premium. The increase in the external finance premium is likely to have an adverse influence on aggregate spending and production. A key premise of the bank lending channel is that bank loans must be viewed as imperfect substitutes to other short-term credit both on the liability side of firms and the asset portfolio of banks. This implies that firms will not offset a reduction of bank loans by simply issuing new short-term debt and that banks will not neutralize the effects of a monetary tightening on their loan portfolio by simply cutting back their holdings of short-term credit.
109. During the period of high inflation in Brazil, bank credit was relatively low and, indeed, the main source of revenue for banks was the float. The size of bank revenues from the float was so large that banks practically refrained from engaging in credit operations, thus making them virtually immune to credit risk. In particular, for several years through end-March 1993 total financial system credit to the private sector was less than R$1 billion (about 5 percent of GDP) (Figure 21). As the economy stabilized under the Real Plan, revenues from the float virtually vanished and banks were compelled to turn to credit operations as the main source of business, and as a result they became vulnerable to credit risks.59 In the process, there was a sharp consolidation of the banking system as many banks were unable to manage the transition to a low inflation environment. In Brazil, therefore, one would expect the bank lending channel to be practically irrelevant during high inflation, but to gradually gain importance as the economy stabilizes.
Brazil: Net Private Lending to the Private Sector
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.Brazil: Net Private Lending to the Private Sector
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.Brazil: Net Private Lending to the Private Sector
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.110. The balance sheet channel of monetary policy works by affecting the external finance premium through changes in the borrowers’ financial position, often represented by their net worth.60 In particular, the proponents of the balance sheet channel argue that monetary policy operates not only through interest rates and the exchange rate effects but also through the borrowers’ financial position by altering the present values of their net cash flows and collateral.61 In turn, changes in the borrowers’ financial position are likely to influence the external finance premium facing borrowers, and thus their investment and other spending decisions.62 In particular, the lower the borrowers’ net worth is, the higher the external finance premium is likely to be, hence entailing adverse effects on real spending and output.63
111. The response of the borrowers’ net worth to central bank actions depends heavily on the duration of net cash flows and collateral derived from the borrowers’ assets, which affect the present values of these flows. Indeed, the longer the duration of the stream of cash flows, the more sensitive the response of present values to changes in interest rates. Therefore, if borrowers (households and firms) have balance sheets where the duration (defined as average maturity) of assets exceeds the duration of liabilities, their net worth would be inversely related to interest rates. This is likely to be the case in Brazil where most households and firms are reported to be borrowing on a short-term basis. In addition, central bank actions have an impact on equity prices. For example, when the central bank tightens monetary policy, households and firms are likely to find themselves with a shortfall of money balances, leading them to sell stocks in order to restore asset market equilibrium. As a result stock prices are likely to fall, causing the value of loan collaterals to drop, hence raising the external finance premium and scaling down spending decisions.64 Alternatively, stock prices could fall as a result of an increase in interest rates that is generally associated with a tighter monetary stance.
112. We also would expect the balance sheet channel to be weak during a high inflation environment because the duration of debt instruments, particularly nonindexed debt, is inversely linked to the level of inflation. Indeed, in the extreme case, the duration of debt instruments would asymptotically converge to zero as inflation rises toward high levels. In such a situation interest rate movements will have a very limited impact on equity prices, in turn resulting in only marginal effects on the net worth of households and firms. However, with the stabilization of the economy in recent years, the duration of debt has risen, leading in turn to a gradual restoration of the effectiveness of the balance sheet channel. In particular, in January 1994 the average maturity of all federal securities was about three months, (about one week for nonindexed federal securities), but by end-October 1997 it had risen to about seven months, as inflation fell sharply under the Real Plan (Figures 22 and 23).
Brazil: Average Maturity of Federal Securities
(in number of months)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.Brazil: Average Maturity of Federal Securities
(in number of months)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.Brazil: Average Maturity of Federal Securities
(in number of months)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.
Brazil: Average Maturity of Federal Securities
(in number of months)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Includes federal securities indexed to the general price index (IGP-M), the reference interest rate (TR), the interbank interest rate (SELIC), the long-term interest rate (TJLP), and the exchange rate.Brazil: Average Maturity of Federal Securities
(in number of months)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Includes federal securities indexed to the general price index (IGP-M), the reference interest rate (TR), the interbank interest rate (SELIC), the long-term interest rate (TJLP), and the exchange rate.Brazil: Average Maturity of Federal Securities
(in number of months)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Includes federal securities indexed to the general price index (IGP-M), the reference interest rate (TR), the interbank interest rate (SELIC), the long-term interest rate (TJLP), and the exchange rate.113. It is relatively more difficult to gauge the relative strength of the credit channel, in large part because it is difficult to distinguish conclusively the effects of the balance sheet channel from the effects of the bank lending channel, and for that matter from the effects of the Tobin’s q theory of investment and the wealth effects on consumption. However, using stock prices as a proxy for the variables that illustrate the credit channel, it appears that the credit channel may have been a channel of monetary transmission in the Brazilian economy (Figures 24 and 25). It is more difficult to detect a positive correlation between equity prices and real GDP growth.
Brazil: Inflation (IGP-DI) and Changes in Real Stock Prices
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Nominal stock prices of BOVESPA adjusted to IGP-DI.Brazil: Inflation (IGP-DI) and Changes in Real Stock Prices
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Nominal stock prices of BOVESPA adjusted to IGP-DI.Brazil: Inflation (IGP-DI) and Changes in Real Stock Prices
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Nominal stock prices of BOVESPA adjusted to IGP-DI.
Brazil: Growth in Real GDP and Changes in Stock Prices
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Nominal stock prices (BOVESPA) adjusted to IGP-DI.Brazil: Growth in Real GDP and Changes in Stock Prices
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Nominal stock prices (BOVESPA) adjusted to IGP-DI.Brazil: Growth in Real GDP and Changes in Stock Prices
(quarterly growth rates, in percent)
Citation: IMF Staff Country Reports 1998, 024; 10.5089/9781451805888.002.A004
Source: Central Bank of Brazil.1 Nominal stock prices (BOVESPA) adjusted to IGP-DI.C. Conclusions
114. This chapter has analyzed the transmission mechanism of monetary policy in Brazil by focusing on how changes in interest rates, the exchange rate and conditions in credit markets, influence real output growth and other real economic variables. The graphical analysis carried out here suggests that interest rates, the exchange rate, and credit factors may have been channels for monetary transmission in Brazil. In contrast with expectations, interest rates and the exchange rate also would appear to have been channels of monetary transmission during high inflation periods. Evidently, these results should be interpreted as very preliminary and need to be subject to more robust econometric analysis. An analyses of monetary transmission also should be based on a closed model by including a central bank’s reaction function describing how the central bank adjusts the interest rate in response to key developments in the economy, namely real GDP, inflation, and the exchange rate.
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Prepared by Rogerio Zandamela.
Among the possible channels of transmission of monetary policy, the interest rate channel is undoubtedly the one that has received the greatest attention in the economics literature, in large part because it is the key mechanism of transmission in the standard Keynesian model. A number of economists, including Taylor (1995), and Ramey (1993) have argued that there is a strong interest rate channel. In contrast, Bernanke and Gertler (1995) were unable to validate statistically the existence of a significant interest rate channel. Indeed, it was the inability of some empirical studies to validate the interest rate channel that stimulated the research for alternative transmission mechanisms of monetary policy.
Recent analysis documenting the importance of the exchange rate channel includes Taylor (1993, 1995), Duguay (1994), and Thiessen (1995).
As suggested by Mundell (1992) the interest rate parity relationship stipulates that the interest rate differential between two countries is equal to the rate of change in the bilateral expected exchange rates. If not, with capital mobility, funds will flow toward the country with a higher interest rate until equalization of expected returns is achieved.
In Taylor (1993, 1995) the transmission mechanism operates through the exchange rate and two interest rates, short-term rates and long-term rates, unlike the traditional Keynesian model which has only one interest rate. In Meltzer (1995) the transmission mechanism focuses on a wide spectrum of asset market prices, beyond short-term rates, long-term rates and the exchange rate.
Including Romer and Romer (1989), Bernanke and Blinder (1992) and Christiano, Eichenbaum and Evans (1994a, 1994b).
The lending operations of the central bank at the minimum rate (TBC) are subject to limits that are dependent on the nature and amount of guarantees offered by the borrower. The TBAN is the rate that the central bank applies for financial assistance operations to banks that want to borrow amounts in excess of the limits applied on borrowing at the TBC.
The SELIC rate is the relevant interest rate in the overnight interbank market only when public sector debt instruments are used as collateral and it is the most important reference rate in Brazil’s economy. However, when private debt instruments are used as collateral, the relevant interest rate in the overnight interbank market is the interbank certificates of deposits rate (“overnight CDF).
Of course, this implies that the overnight interbank market was initially in a position of equilibrium.
Abstracting from other factors such as fiscal policy, monetary policy in major partner countries, and political events.
There are a number of channels through which changes in interest rates affect aggregate demand and spending. These include a cost of capital effect (on consumer durables, investment in housing, business investment on plant and equipment, and inventory holdings); a wealth effect on household spending; a cash flow effect on firms and households (also referred to as a liquidity constraint effect); and an intertemporal substitution effect on consumer spending (the incentive to save rather than to spend). These effects are discussed in greater detail in Duguay (1994).
Other lags were tried but were less significant.
This result is also robust with the substitution of industrial production and output for real GDP. It was not possible to analyze the impact of monetary impulses on aggregate demand (and its components) because of unavailability of quarterly data. The existing quarterly (and monthly) series on aggregate demand only cover the period from January 1996. Prior to January 1996 there is only annual data, which is not suitable for this type of analysis.
There are two legally recognized exchange rate markets in Brazil: the commercial or free market and the fluctuating or tourism market. The commercial market handles most financial and trade related transactions (about 85 percent of total turnover) and the fluctuating market covers transactions related to tourism and some nontrade related services. The band system applies to both exchange rates. Even without the formal introduction of the band system, the exchange rate had remained in a narrow band between October 1994 and February 1995, after being allowed to float during the first three months of the Real Plan.
For example, this could be the case if the market felt that the SELIC rate adjusted by the expected depreciation in exchange rate was unattractive when compared with equivalent instruments in international markets.
Evidently, the central bank could decide to move the miniband to a more depreciated level even much before the exchange rate reaches the ceiling of the miniband. Furthermore, the central bank could in theory decide to move the miniband to a more appreciated level even with the exchange rate under pressure. To sustain this situation, the central bank would need either to raise interest rates or be willing to supply reserves to the exchange market. In the contrary, a parallel market will emerge to fill the gap.
In addition to the substitution effect, exchange rate movements in the short run have offsetting income effects, particularly through possible changes in the country’s terms of trade. Accordingly, if a country exerts some influence on the price of its exports while being a price taker for its imports, then a depreciation of the currency could result initially in lower export receipts and higher import expenses. But over time the substitution effects are expected to prevail.
This implies that the positive performance in economic activity during the Real Plan would have been much higher if fiscal policy had been stronger and the real exchange rate had not appreciated as much.
This also can be interpreted to mean that firms view internal funds, bank loans, and other sources of credit as imperfect substitutes.
By end-1997 total financial system credit to the private sector had risen to more than R$200 billion (about 25 percent of GDP). However, less than R$50 billion of the total financial system credit were in the form of holdings of federal securities.
The lower the net worth of the borrowers is, the smaller the collateral for the loans and the higher the potential losses from adverse selection. When the net worth of borrowers falls, bank lending to finance investment will drop because it is more likely that lenders will not be paid back.
Most of the research on the credit channel has focused on the impact of monetary impulses on spending decisions by business firms. However, as suggested by Bernanke and Gertler (1995), the credit channel is equally relevant for consumer spending, namely durables and housing purchases. In particular, it could operate either through changes in banks’ desire to lend or through changes in consumers’ desire to spend (liquidity or cash flow effects) in response to monetary impulses (e.g., Mishkin, 1995).
To the extent that changes in the net worth are correlated with interest rate movements, some of the effects of the balance sheet channel may be captured by the interest rate channel.
The underlying insight is that a weaker financial position will induce borrowers to raise their potential conflict of interest with lenders either by providing less collateral for their loans or reducing their down payment.
The impact of changes in equity prices on spending decisions can also be explained through Tobin’s q theory of investment and wealth effects on consumption. According to Tobin (1969) q is the market value of firms expressed in terms of the replacement cost of capital. Following this theory, the transmission of monetary policy operates through its effects on the valuation of assets. Accordingly, lower equity prices entail a lower q, which in turn induces a drop in investment spending because for firms to acquire new plant and equipment a larger issue of equity is needed. The wealth effect on consumption stipulates that when equity prices fall, the level of financial wealth of consumers will drop, thus lowering consumption spending via a reduction of lifetime resources of consumers (Modigliani, 1971).
