What is The True Dimension of The Fiscal Problem?

BRAZIL ECONOMICS - Report 08 Nov 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

When one speaks of fiscal unanchoring, the fear immediately arises that the country is once again headed toward “fiscal dominance”. This is not the case now, and the main reason is that the Central Bank is now formally independent and will use the instrument within its grasp – the SELIC rate – to bring inflation to the target by the end of 2022. To achieve this outcome, it will have to keep monetary policy restrictive throughout 2022 by maintaining high rates in the short end of the yield curve (from zero to one year).

However, they will also remain high in the long end of the curve due to the risk premium provoked by the absence of a fiscal anchor. One of the objectives of this report is to show that in the absence of a fiscal anchor, the implicit interest rate on the public debt will rise, which combined with maneuvers to elevate discretionary spending will put the debt/GDP ratio back on a rising path.

Our exercise was conducted by assuming that the “PEC dos Precatórios” (proposed constitutional amendment of judicial credit warrants, more frankly called the “PEC of Default”) will be approved, a hypothesis that might be avoided if pressures on Congress from more far-thinking interests gain strength. All the same, it is important to examine the consequences of this type of measure, which we do at the end of this text.

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