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March 22nd 2005

Brazil’s monetary policy called into question

Despite raising interest rates to 19.25% this month, Brazil’s Central Bank is drawing increasingly harsh criticism from economists around the world. Their complaints are contrary to what you would expect, as many think interest rates are still too low! Under pressure to contain aggregate demand and inflation, the bank has raised rates by over 3% in less than a year. Last year, critics chastised the bank for not dropping rates quickly enough, when Brazil’s economy began to spiral into recession. This year, they have argued the bank’s monetary policy has had no discernible effect on Brazil’s economy.

Analysts have observed a few factors which may diffuse the effect of interest rates. First, borrowing rates are actually decreasing despite an increase in federal funds rates. Second, there are still too many loans made below the prevailing interest rate. Brazil’s government makes many exceptions for those who cannot afford to pay such high rates of interest on housing loans, for example. What should Brazil’s Central Bank do? Some say it should continue to raise rates at a pace consistent with inflation. Other say it should wait until the effects of previous rate hikes trickle down through the economy, and run their course. Morgan Stanley reports:

Brazil’s economy has long shown that it is responsive to interest rates.   If there is an anomaly in the Brazilian case, it is not the limited potency of monetary policy or the lag between monetary tightening and the slowdown in the economy, but the starting point for interest rates.  Brazil has only briefly seen real interest rates in the single digits twice in the past decade.

Read More: Brazil: The Monetary Policy Blame Game

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Posted by Adam Kritzer | in Exotic Currencies | No Comments »

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