Fiscal costs of monetary policy: indirect effects of an interest rate shock on Brazilian public net debt

CARVALHO, LAURA; DINIZ, ANDRÉ; PEDROSA, ÍTALO; ROSSI, PEDRO

doi:10.1590/0101-31572015v36n03a06

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Brazilian Journal of Political Economy

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Articles • Rev. Econ. Polit. 36 (3) • Jul-Sep 2016 • https://doi.org/10.1590/0101-31572015v36n03a06 copy

Fiscal costs of monetary policy: indirect effects of an interest rate shock on Brazilian public net debt

Custos fiscais da política monetária: os efeitos indiretos de um choque de juros sobre a dívida líquida do setor público

Authorship SCIMAGO INSTITUTIONS RANKINGS

ABSTRACT:

The paper estimates the fiscal cost of an increase in the Brazilian policy interest rate - the SELIC - by considering not only the direct effect on the yield of public bonds that are indexed to the SELIC, but also indirect effects on: (i) the yield of public bonds that are indexed to the exchange rate and inflation, and (ii) the stock of public net debt through adjustments in the value of international reserves measured in domestic currency. Projections are based on the estimation of the relationship between interest rates, exchange rates and inflation by means of a vector auto-regression. We conclude that the inclusion of such indirect effects has an ambiguous effect on the response of the implicit interest rate on public net debt to shocks in the SELIC, when adjustments in the value of international reserves are not considered. However, the inclusion of the latter amplifies the fiscal cost of a more restrictive monetary policy. These results call for a better coordination between monetary, fiscal and exchange rate policies in Brazil.

KEYWORDS:
Brazilian public debt structure; monetary policy; interest rate-exchange rate nexus; international reserves; debt sustainability

Period		Shock of one Cholesky S.D.			Shock of 0.5 p.p.
	SELIC	ER	IPCA	SELIC	ER	IPCA
0	0,0%	0,0%	0,0%	0,0%	0,0%	0,0%
1	1,5%	-0,1%	0,0%	4,8%	-0,5%	0,0%
2	2,5%	-0,3%	-1,0%	8,0%	-0,9%	-3,3%
3	3,2%	-0,5%	-0,1%	10,3%	-1,5%	-0,2%
4	4,1%	-0,8%	-1,0%	13,1%	-2,5%	-3,1%
5	4,4%	-0,7%	0,5%	14,4%	-2,2%	1,8%
6	4,7%	-0,6%	-0,9%	15,3%	-1,9%	-3,0%
7	5,1%	-0,8%	-1,8%	16,5%	-2,6%	-5,7%
8	5,3%	-0,9%	-2,7%	17,3%	-3,0%	-8,4%
9	5,5%	-1,0%	-2,5%	17,9%	-3,3%	-7,9%
10	5,7%	-1,3%	-3,1%	18,7%	-4,0%	-9,7%
11	5,8%	-1,3%	-3,0%	18,9%	-4,1%	-9,3%
12	5,7%	-1,2%	-2,9%	18,7%	-4,0%	-9,1%
13	5,6%	-1,3%	-2,7%	18,5%	-4,1%	-8,6%
14	5,5%	-1,3%	-2,9%	18,0%	-4,1%	-9,2%
15	5,4%	-1,3%	-2,8%	17,7%	-4,1%	-8,9%
16	5,4%	-1,3%	-3,3%	17,6%	-4,2%	-10,4%
17	5,3%	-1,3%	-3,2%	17,4%	-4,2%	-10,1%
18	5,3%	-1,3%	-3,1%	17,4%	-4,2%	-9,8%
19	5,3%	-1,3%	-3,0%	17,3%	-4,3%	-9,5%
20	5,3%	-1,3%	-2,9%	17,2%	-4,2%	-9,2%
21	5,2%	-1,3%	-2,9%	17,1%	-4,2%	-9,0%
22	5,2%	-1,3%	-3,0%	17,0%	-4,2%	-9,5%
23	5,2%	-1,3%	-2,9%	17,0%	-4,1%	-9,1%
24	5,2%	-1,3%	-3,0%	17,0%	-4,2%	-9,3%

Indexes (bonds)	As it occurs in practice	Hypothesis adopted
SELIC (LFT)	There is no interest coupon payment and at maturity the main value updated by the SELIC rate is paid.	The interest payment rate is affected by 0.5 p.p. one month after the shock. The initial value is the average implicit interest rate over the previous 12 months.
Inflation (NTN-B)	At maturity, the main value updated by the accumulated IPCA is paid and there is a semi-annual interest coupon payment¹.	The yield of the bond is affected indirectly by the shock, according to its effect on monthly inflation². The initial value is the average implicit interest rate over the previous 12 months.
Fixed-rate (LTN and NTN-F)	The fixed interest rate is determined at the time of the sale of the bond, with discount, on the primary market, but is only paid at the maturity of the bond³.	The fixed interest payment is kept constant and reproduces the average implicit interest rate over the 12 months prior to the shock.
Exchange	These bonds may have different formats; the most common one pays interest coupon and the main one is updated by the variation of the exchange rate.	The yield of the bond is affected indirectly by the shock, according to its effect on the monthly exchange rate.
TJLP	The TJLP indexes BNDES loans, and can be changed if the SELIC rate changes substantially.	The implicit interest rate is kept constant, reproducing the average of the 12 months prior to the shock.
TR (CFT, NTN, CDP)	The TR pays different bonds that are not offered at auction. The SELIC has an indirect impact on TR⁴.	The implicit interest rate is kept constant, reproducing the average of the 12 months prior to the shock.

Scenarios	Δ GDP (%)	Primary surplus (%GDP)
Base	2.3	2.0
Scenario 1 (recession)	0	2.0
Scenario 2 (growth)	4.5	2.0
Scenario 3 (fiscal expansion and growth)	5	1.5

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E-mail: cecilia.heise@bjpe.org.br

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[TFN1] Source: Authors' elaboration.

[TFN2] Note: the initial values considered for the monthly IPCA and real-dollar exchange rate were 0.48% (average monthly inflation in 2013) and R$ 2.34 per dollar (average in December, 2013), respectively.