Why Are Policy Real Interest Rates So High in Brazil? An Analysis of the Determinants of the Central Bank of Brazil’s Real Interest Rate

Abstract

This article discusses the determinants of Brazil’s high policy real interest rates by considering two opposing views, the orthodox and heterodox approaches. While orthodox authors defend the position that bad domestic policies are the cause of the high interest rate, heterodox economists claim that the international financial system and orthodox policies influence the level of the policy rate in Brazil. The aim of this study is to assess whether the proposed arguments can be supported when comparing Brazilian real interest rates with other developing countries under the same monetary regime. A panel regression with 11 developing countries over the period 1996–2015 is estimated to test these hypotheses. The conclusion is that, although the orthodox and heterodox arguments are both coherent, when comparing stylized facts and testing the hypotheses econometrically neither is sufficient to elucidate the Brazilian case. The article concludes by suggesting that there might be political causes of the high real interest rates in Brazil such as a politically influential rentier class.

Keywords:

• Brazil
• Central Bank
• interest rate
• monetary policy
• political economy

JEL Classification:

• E43
• E58

Notes

1 CBRIR is the central bank nominal interest rate minus the inflation rate based on the GDP deflator. The detailed measure of it for each country in the sample is described in Appendix A.

2 Other factors mentioned by mainstream authors are the low level of dollarization and low investment grade in Brazil (Bacha et al., 2009), the high level of subsidized credit that pushes equilibrium interest rates up (Hausmann, 2008; Lopes, 2014; Segura-Ubiergo, 2012), lack of central bank independence (Arida et al., 2003; Favero and Giavazzi, 2002; Nahon and Meurer, 2009; Segura-Ubiergo, 2012) and high debt-to-GDP ratio (Arida et al., 2003; Favero and Giavazzi, 2002; Gonçalves et al., 2007; Segura-Ubiergo, 2012). However, due to data unavailability, the first three mechanisms could not be considered. The last factor has been tested by Muinhos and Nakane (2006), who didn't find a clear relationship between debt-to-GDP ratio and real interest rates, reason why it is also left out of this paper.

3 The indexation of government bond interest rates to the central bank interest rate is also mentioned by Baltar (2015), Modenesi and Modenesi (2012) and Oreiro et al. (2012) as a factor contributing to the high Brazilian real policy rate. However, other developing countries under IT also have bond interest rates indexed to inflation (Deacon et al. 2004), so it seems this is not a particularity of the Brazilian economy. Because of the inability of measuring the level of indexation between those variables, I leave this argument out of this analysis.

4 Appendix A displays detailed information on these variables.

5 Barbosa-Filho (2008, p.189) also affirms that, even though inflation-targeting has reduced the base domestic interest rate in Brazil, the rate still persisted well above international standards.