The discussion about the reasons for the high Brazilian interest rate gained momentum. Samuel Pessôa, for example, has argued that the explanation lies in high fiscal spending and, consequently, low domestic savings, which would cause chronic excess demand in the country.
This is the most common view, and for a long time attempts to examine the problem from other angles, including elements from the most recent academic literature, found little space. Fortunately, there has been some openness in recent times.
A criticism that has been gaining more ground is our 3% inflation target. In a recent text in Folha, André Roncaglia draws attention to the fact that an excessively ambitious target for the Brazilian structure could make it difficult to anchor expectations and lead the Central Bank to keep interest rates higher for longer.
Bráulio Borges adds that in the face of increasingly frequent extreme weather events, a target such as the current one will force higher interest rates.
Considerations of this type regarding the inflation target have also been made both in a more academic context, such as in the article by Aloisio Araujo and co-authors in the American Economic Journal: Macroeconomics, for example.
In research by Made/USP, we found little evidence based on 15 countries that domestic savings have a significant effect on structural interest rates. Still, one can be willing to accept the argument and assume that there is some excess demand at the moment, given the low level of unemployment, and that an increase in the surplus could help reduce interest rates.
Regarding the 3% target, we find strong evidence in the data that it puts pressure on the interest rate, in line with the arguments above. Missing from the discussion, however, is a third element, which receives much less attention: exchange rate volatility.
When the real depreciates, imported consumer goods and inputs become more expensive, inflation rises and monetary policy responds. The obvious objection is that this should not be a problem: when the real appreciates, the pressure would reverse and, on average, the effect would cancel itself out.
However, there is already ample evidence that this transfer is asymmetric: inflation rises more during depreciation than it falls when the currency appreciates. In other words, in countries with a volatile exchange rate, each cycle of currency rise and fall leaves a higher level of inflation as a residue.
The problem is central in the Brazilian case. The real is one of the most volatile currencies in the world: measured by daily variation over the last three years, its volatility is the highest among the 31 countries covered by European Central Bank data, ahead of South Africa and Mexico.
Two reasons for this large fluctuation in the real stand out. The first is the high interest rates themselves, which make the country an attractive destination for carry trade operations, in which investors borrow resources where interest rates are low and invest them where they are high. This type of flow increases external vulnerability: in the face of any change, effective or just expected, capital moves and generates an exchange rate shock.
The second is the unusual configuration of our derivatives market, disproportionately large in relation to the spot market and, peculiarly, the place where much of the formation of the dollar price in Brazil takes place.
It is no coincidence that the Brazilian dollar futures contract became the most traded on the stock exchange in the world among currency contracts, which is anomalous for an economy with the participation that ours has in global trade.
The Central Bank itself estimates that more than half of the exchange rate volatility during the pandemic came from negotiations in this market.
The three problems feed on each other. Volatile exchange rates generate more inflationary pressure; the Central Bank responds with higher real interest rates, and the higher the less realistic the target is; High interest rates reinforce the country's role as a carry trade destination, which returns volatility to the currency.
An agenda that combines greater efficiency in public spending, especially with a reduction in tax spending, a reduction in exchange rate volatility and a review of the inflation target to realistic levels has a chance of producing a significant drop in real interest rates, helping to stabilize public debt and the indebtedness of families and companies.
