Opinion – Solange Srour: Attack on high interest rates begins, but not in the right way

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Explaining the anomaly of high real interest rates in Brazil is a recurring question for economists. The discussion reappears amid the wait for fiscal adjustment measures after the approval of the Transition PEC. The attack on high interest rates is natural, as they will have a strong impact on the public deficit; just as the timing is right, as inflation has eased and the economy is slowing down.

There are several theses that try to establish the causes of high interest rates. Some do not hold up, given our historical experience, but even so, every now and then they reappear. Others, which make more sense, bring unpopular diagnoses and, therefore, are most often put aside.

In the first group, it is argued that the high real interest rate is the result of a “pact” between market investors (beneficiaries of profitable investments in public securities) and the Central Bank, which aims to have the reputation of being conservative. Marcos Lisboa, in his most recent article in Sheetquite clearly rejects the idea that the market can be an organized union, being actually formed by managers who manage people’s savings and seek the best investment, given the information available.

On the other hand, there is no evidence that our Central Bank has been overly conservative. Since the introduction of the inflation targeting regime in 1999, inflation has been below the center of the target for only four years. In addition, we had six years of inflation above the top of the target and are on track for the seventh year, in line with the expectations of the Focus report.

Another very popular explanation is that the high interest rate stems from a multiple equilibrium problem. This hypothesis attributes to an economic policy error the fact that we are in a “bad equilibrium”, and a movement towards the “good level” could be obtained without incurring costs, such as a fiscal effort. This conjecture was tested between 2011 and 2013, when it was believed that the Brazilian economy was in an equilibrium of high interest rates and an appreciated exchange rate that could revert to an equilibrium of lower interest rates and a depreciated exchange rate.

In August 2011, even with rising and above-target inflation expectations, the Copom opted to start a strong cycle of reducing the Selic rate by 12.50%, which reached 7.25% in October 2012. The result was a double-digit inflation, even with the support of the explicit policy of controlled prices, with the Selic reaching 14.25% in 2015.

Among the best-founded theses to justify high real interest rates, two are worth mentioning in the current situation, as they involve the behavior of public spending and the existence of mechanisms that obstruct the transmission channel of monetary policy.

Regarding the first thesis, high real interest would be the consequence of a fiscal policy that systematically produces a trend of strong growth in expenditure as a proportion of GDP. From 1991 to 2016, government expenditures grew at rates higher than GDP, jumping from 10.8% to 19.8% After the approval of the spending ceiling, from 2017 onwards we had a more contained growth, with the exception of the period of pandemic. The fiscal advance puts pressure on aggregate demand and requires a high interest rate to balance investment and savings.

More importantly, fragile fiscal regimes, which undermine expectations regarding debt solvency, increase the risk premium demanded by Treasury lenders and, consequently, put pressure on interest rates. For no other reason, the spending ceiling, as a credible fiscal rule, brought about a substantial and prolonged drop in real interest rates.

In the second thesis, the real interest would be higher in Brazil because part of the credit market operates with a lower interest rate, subsidized and insensitive to monetary policy, leaving a portion of aggregate demand beyond the reach of the monetary authority. In view of this, the Central Bank, in order to maintain inflation at the target, must adopt a tougher interest rate policy compared to the one that would be adopted in the absence of such obstruction in the transmission of monetary policy.

The reduction of exaggerated BNDES subsidies since 2017 not only reduced the economy’s equilibrium interest rates, but also generated strong growth in long-term credit in the capital market, in addition to increasing the effectiveness of monetary policy.

The signal we have been receiving since the approval of the Transition PEC is that the economic policy has been directed towards increasing the risk of interest rates remaining high and rising even more. More than implementing a tidying brake, it will be necessary to accelerate reforms that help with fiscal consolidation and shield the achievements we have achieved in recent years.

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