The Controversy over the Spending Cap

BRAZIL ECONOMICS - Report 07 Oct 2019 by Affonso Pastore, Cristina Pinotti and Marcelo Gazzano

The nervousness over the sluggish cyclical recovery has prompted the suggestion that the spending cap established by Constitutional Amendment 95 should be relaxed to restore the government’s ability to use countercyclical fiscal measures. In support of this proposal, its advocates argue that with the decline of the real interest rate (which is supposedly permanent) and the current economic growth rate (which would not fall with “fiscal rule” alteration), it would be possible to stabilize the debt/GDP ratio with smaller primary surpluses, allowing relaxation of the spending cap. In this report, we point out the errors of this argument. The spending cap is only the commitment instrument, to which compliance requires not only the pension reform, but also a series of other fiscal adjustments. If the government relaxes the ceiling before completing the cycle of reforms to assure control of expenditures, it will raise the level of uncertainty, along with the risk premiums and interest rate, pouring cold water on the sustained growth pick up and aggravating the debt dynamics.

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