What’s Portuguese for Volcker?
Brazil has increased its “Selic” short-term interest rate to 12.25 per cent - a full 700 basis points above the country’s current inflation. These high real interest rates have produced a sound economy. Brazil’s savings rate is double that of the US, its balance of payments deficit is modest, its growth rate much faster and its inflation rate comparable. Brazilian monetary policy since 2002 offers important pointers to Ben Bernanke.
Brazil’s high short-term rates were traditionally thought to reflect the economy’s high risk, but that is no longer the case, as high real interest rates since 2002 have stabilised both the foreign exchange position and the economy. The country’s foreign debt is below 50 per cent of GDP, the current account is close to balance and the public sector is in only modest deficit, even after deducting high interest costs on government debt. Brazil’s perceived risk level is now moderate; its long term debt was recently upgraded to investment grade and trades at less than 1 percentage point above equivalent Treasuries.
Although the rate increase was undertaken to combat inflation, current expectations are for Brazil’s inflation to remain at around its current 5 per cent level. Thus Brazil’s 12.25 per cent Selic rate, if one deducts 1 per cent for risk and 5 per cent for inflation and adds back 4 per cent for US inflation, would be equivalent to a Federal Funds target rate of 10.25 per cent compared to the current 2 per cent.
High real interest rates have a number of advantages. Brazil’s gross national savings rate is double that of the US, as saving is properly rewarded by substantial real returns. Its balance of payments deficit is modest, as domestic consumption is restrained by its high savings propensity. Economic growth is much faster, as resources are devoted to productive investment rather than being wasted in cheap-money speculation. Even Brazil’s government deficit is lower, as its leftist law-makers are forced to reckon with the high interest cost of deficit financing.
The US is currently running an excessive payments deficit, has a weak and declining currency, a low or negative consumer savings rate and a government addicted to deficit finance even in boom times. A Brazilian-style monetary policy might just cure those problems. A Brazilian-style monetary policy just might give Bernanke some ideas.
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