Fiscal costs of monetary policy: indirect effects of an interest rate shock on Brazilian public net debt

Vol. 36 No. 3 (2016)

Jul-Sep / 2016
Published March 1, 2020
PDF-English
PDF-English

How to Cite

Carvalho, Laura, André Diniz, Ítalo Pedrosa, and Pedro Rossi. 2016. “Fiscal Costs of Monetary Policy: Indirect Effects of an Interest Rate Shock on Brazilian Public Net Debt”. Brazilian Journal of Political Economy 36 (3):557-79. https://doi.org/10.1590/0101-31572015v36n03a06.

Fiscal costs of monetary policy: indirect effects of an interest rate shock on Brazilian public net debt

Laura Carvalho
Departamento de Economia da Universidade de São Paulo.
André Diniz
Escola de Economia de São Paulo, da Fundação Getulio Vargas.
Ítalo Pedrosa
Instituto de Economia da Universidade Estadual de Campinas.
Pedro Rossi
Instituto de Economia da Universidade Estadual de Campinas.
Brazilian Journal of Political Economy, Vol. 36 No. 3 (2016), Jul-Sep / 2016, Pages 557-579

Abstract

The paper estimates the fiscal cost of an increase in the Brazilian policy interest rate – the SELIC – by considering not only the direct effect on the yield of public bonds that are indexed to the SELIC, but also indirect effects on: (i) the yield of public bonds that are indexed to the exchange rate and inflation, and (ii) the stock of public net debt through adjustments in the value of international reserves measured in domestic currency. Projections are based on the estimation of the relationship between interest rates, exchange rates and inflation by means of a vector auto-regression. We conclude that the inclusion of such indirect effects has an ambiguous effect on the response of the implicit interest rate on public net debt to shocks in the SELIC, when adjustments in the value of international reserves are not considered. However, the inclusion of the latter amplifies the fiscal cost of a more restrictive monetary policy. These results call fora better coordination between monetary, fiscal and exchange rate policies in Brazil.

JEL Classification: E43, E52, E63, H63.


Keywords: Brazilian public debt structure monetary policy interest rate-exchange rate nexus international reserves debt sustainability