Monetary policy: Fiscal and external influences

BRAZIL ECONOMICS - Report 23 Apr 2018 by Affonso Pastore, Cristina Pinotti, Marcelo Gazzano and Caio Carbone

With inflation contained, expectations anchored and the long end of the yield curve not indicating any sign of eroded credibility of the Central Bank, the maintenance of the interest rate at low levels for an extended period depends mainly on the success of fiscal consolidation. The current government, bereft of political support, has abandoned all efforts to win approval of the pension reform proposal, leaving this task to the next administration. Fortunately, the low international risk aversion has been keeping demand for Brazilian assets high, subduing Brazil’s CDS quotations and preventing the exchange rate from depreciating unduly, keeping the window of opportunity for fiscal consolidation open. In this note we show that the external conditions are the only ones acting to reduce the quotations of Brazilian CDS. Without the external effect, those quotations would be one of the highest among the emerging countries, clearly reflecting the gravity of the fiscal problem which, if not resolved by the next government, will make the Central Bank’s efforts to maintain the basic interest rate low impossible.

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