Banco Central do Brasil The Managed Floaters Float

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Banco Central do Brasil The Managed Floaters: Float or Sink? Float! The Case of

Banco Central do Brasil The Managed Floaters: Float or Sink? Float! The Case of Brazil Ilan Goldfajn April 2001 1

 • How the Inflation Targeting Regime has Operated in the Last Two Years.

• How the Inflation Targeting Regime has Operated in the Last Two Years. • The Effect of the External Shock in 2001 and Pass-through • Sensitivity to Interest Rates and the Effect of Depreciation 2

Inflation Targeting Inflation Rate - IPCA (% over year ago) Inflation Targeting 10. 0%

Inflation Targeting Inflation Rate - IPCA (% over year ago) Inflation Targeting 10. 0% 8. 0% 6. 0% 4. 0% 2. 0% 0. 0% Jan Apr Jul Oct Jan Mar 97 98 99 00 01 Dotted lines represent the inflation targets for 1999, 2000 and 2001 3

Inflation Expectations Market Inflation Expectations median of IPCA for 1999, 2000, 2001 and 2002

Inflation Expectations Market Inflation Expectations median of IPCA for 1999, 2000, 2001 and 2002 (daily figures: June 24, 1999 to April 20, 2001) 10. 00 1999 9. 00 8. 00 2000 6. 00 5. 00 2001 4. 00 2002 Source: Investor Relations Group / Banco Central Apr 11 Mar 07 Jan 29 Dec 21 Nov 16 Oct 09 Sep 01 Jul 28 Jun 23 May 18 Apr 11 Mar 03 Jan 28 Dec 22 Nov 17 Oct 08 Sep 02 2. 00 Jul 29 3. 00 Jul 24 (%) 7. 00 4

Economic Activity GDP (% real variation) 5. 0 4. 5 4. 0 3. 5

Economic Activity GDP (% real variation) 5. 0 4. 5 4. 0 3. 5 3. 0 2. 5 2. 0 1. 5 1. 0 0. 5 0. 0 4. 46 4. 30 2001* 0. 79 0. 22 1998 /* 2001 estimates 1999 6

Interest Rate Over-Selic Rate (daily figures: January 4, 1999 to April 20, 2001) 50

Interest Rate Over-Selic Rate (daily figures: January 4, 1999 to April 20, 2001) 50 44. 99% % p. y. 40 30 20 16. 30% 10 Jan 99 Apr Jul Oct Jan 00 Apr Jul Oct Jan Apr 01 7

Fiscal Targets - Primary Surplus R$ billion 40 35 Occurred 30 25 20 15

Fiscal Targets - Primary Surplus R$ billion 40 35 Occurred 30 25 20 15 Target 10 5 0 Mar 99 Jun Year cumulative data Sep Dec Mar 00 Jun Sep Dec Mar 01 8

Net Public Sector Debt Average Maturity * - Public Debt 32. 2 31. 6

Net Public Sector Debt Average Maturity * - Public Debt 32. 2 31. 6 29. 3 29. 0 28. 9 26. 5 26. 6 Jan 00 In months 27. 0 Mar 31. 4 29. 8 29. 9 27. 3 May Jul Sep Nov Jan 01 Mar 9

External Shock and the Reaction • Important External Shocks: U. S. Slowdown (recession? )

External Shock and the Reaction • Important External Shocks: U. S. Slowdown (recession? ) and Contagion • There is no fear of floating • In principle exchange rate is the only buffer. However, there is a pass-through from depreciation to inflation. Fear of Inflation. • Pass-through is endogenous depends on output, RER, credibility, policies and etc. 10

FDI: U. S. Slowdown. Size of Decline? Net Foreign Direct Investment - Equity Capital

FDI: U. S. Slowdown. Size of Decline? Net Foreign Direct Investment - Equity Capital Accumulated in the year 35 US$ billion 30. 3 8. 8 7. 1 25. 4 30 25 16. 8 20 15 30. 0 9. 9 10 2. 6 5 7. 2 6. 1 24. 0 5. 2 19. 4 21. 1 23. 2 1998 1999 2000 20. 0 11. 6 0 1996 1997 FDI excluding Privatizations Source: Central Bank of Brazil 2001 * FDI in Privatizations * 2001 year projections 11

Econometric Exercise Domestic Interest Rate Responsiveness to US Interest Rate in Countries without Capital

Econometric Exercise Domestic Interest Rate Responsiveness to US Interest Rate in Countries without Capital Controls US int. rate BP US int. rate x BP 0, 45 (0. 13)** 0, 00 (0. 00) -0, 01 (0. 01) 1, 07 (0. 20)** 0, 20 40 481 Intermediate regimes 0, 05 (0. 19) 0, 00 (0. 00)** -0, 05 (0. 02)** 1, 17 (0. 38)** 0, 21 40 260 Free-floating regimes 0, 91 (0. 18)** -0. 00 (0. 00) 0, 00 (0. 01) 0, 59 (0. 30)** 0, 37 40 193 Whole sample Inflation R-squared Number of differential countries observations Notes: 1. All the regressions contain country fixed effects which are not reported to save space. 2. White heteroskedasticity-consistent stardard errors are in parenthesis. 3. ** and * mean that the estimate is statistically different from 0 at the 5% and 10% significant level respectively. 12

No Fear of Floating. Contagion? Dollar/Euro e Real/Dollar Behavior Average Rate % Deviation 20

No Fear of Floating. Contagion? Dollar/Euro e Real/Dollar Behavior Average Rate % Deviation 20 16. 4 15 11. 7 10 5 0 -4. 0 -5 -3. 4 -10 (Observed average Jan/00 to Apr/01 = Real/Dollar 1, 88 and Dollar/Euro 0, 92) -15 3 24 Jan/00 14 8 29 Feb Mar/00 19 12 2 26 Apr May. Jun/00 17 7 28 Jul. Aug/00 Dollar/Euro 19 10 1 24 15 9 30 20 15 5 Sep Oct Nov/00 Dec/00 Jan/01 Feb Mar Apr/01 Real/Dollar 13

Fear of Inflation and Pass-through Pass-Through Comparison Months Short Sample Long Sample Paper G&W

Fear of Inflation and Pass-through Pass-Through Comparison Months Short Sample Long Sample Paper G&W Regression regression America 3 months 0. 123 0. 117 0. 20 6 months 0. 131 0. 228 0. 53 after 1 year 0. 134 0. 441 0. 69 18 months 0. 134 0. 642 1. 24 14

Passthrough Coefficient Evolution of the Passthrough Coefficient 0. 20 0. 18 0. 16 0.

Passthrough Coefficient Evolution of the Passthrough Coefficient 0. 20 0. 18 0. 16 0. 14 0. 12 0. 10 2000: 4 2000: 3 2000: 2 2000: 1 1999: 4 1999: 3 1999: 2 1999: 1 1998: 4 1998: 3 1998: 2 1998: 1 1997: 4 1997: 3 1997: 2 0. 06 1997: 1 0. 08 15

The Policy Reaction and the Effect • Economy was growing fast. Good timing for

The Policy Reaction and the Effect • Economy was growing fast. Good timing for the required fiscal and monetary tightening. • Monetary policy may be more effective than in previous regime. Signs on term structure and credit growth are encouraging. Signs of sales slowdown. • There is sensitivity to the exchange rate. Is the elasticity large enough? Would depreciation be contractionary this time? 16

GDP Growth: No pro-cyclical policy GDP and Industrial Production Real variation cumulative in 12

GDP Growth: No pro-cyclical policy GDP and Industrial Production Real variation cumulative in 12 months 8 6 4 2 0 -2 -4 -6 1996 I III 1997 I III 1998 I GDP at market prices III 1999 I III 2000 I III Industrial production 17

Economic Activity Month Percentage variation Perspective Month 1/ Year 12 -month -0. 75 -0.

Economic Activity Month Percentage variation Perspective Month 1/ Year 12 -month -0. 75 -0. 89 -5. 25 -3. 59 7. 57 10. 42 31. 80 9. 05 10. 44 8. 50. . . 6. 15 1. Commerce - Billing (São Paulo) - SPC and Telecheque - SPC - Consumer confidence index March 2. Industry - Production - Sales - Employment - Installed capacity utilization (CNI) February 0. 78 2. 75 0. 55 0. 05 6. 53 11. 61 2. 41 1. 09 5. 95 10. 68 1. 43 2. 28 3. Labor market - Unemployment rate - Real income February January -4. 46 -1. 16 -24. 80 -1. 02 -25. 03 -0. 22 Slowdown Down Source: Fcesp, ACSP, IBGE and CNI 1/ Seasonally adjusted series. 18

Trade Balance - monthly and cumulative in 12 months (US$ billion) 0. 6 1.

Trade Balance - monthly and cumulative in 12 months (US$ billion) 0. 6 1. 0 0. 4 0 0. 2 -1. 0 0 -2. 0 -0. 2 -3. 0 -0. 4 -4. 0 - 0. 6 -5. 0 - 0. 8 -6. 0 -1. 0 -7. 0 -1. 2 -8. 0 -1. 4 -9. 0 -1. 6 -10. 0 Mar 01 Jan 98 May Sep Jan 99 Monthly - left scale May Sep Jan 00 May Sep Cumulative in 12 months - right scale 19

Fiscal Results Sensibility analysis % of GDP Itemization Basic scenario Exchange rate (1 pp

Fiscal Results Sensibility analysis % of GDP Itemization Basic scenario Exchange rate (1 pp aa) Selic (1 pp aa) GDP (1 pp aa) Net Debt Nominal - 12 -month 50. 25 50. 46 50. 51 49. 78 3. 39 3. 50 3. 65 3. 36 % of GDP Itemization Exchange rate (1 pp aa) Selic (1 pp aa) GDP (1 pp aa) Net Debt - 12 -month variation 0. 21 0. 26 0. 46 Nominal - 12 -month variation 0. 10 0. 26 0. 03 20

The Fiscal Adjustment Program Fiscal Targets for 1999 -2001 % of GDP PRIMARY SURPLUS

The Fiscal Adjustment Program Fiscal Targets for 1999 -2001 % of GDP PRIMARY SURPLUS 1999 2000 2001 2002 * 3. 10% 3. 25% 3. 00% 2. 70% 3. 00% /* Preliminary 21

Conclusions – No Fear of Floating but Fear of Inflation. Passthrough from exchange rate

Conclusions – No Fear of Floating but Fear of Inflation. Passthrough from exchange rate has been moderate. Future? – Contractionary Monetary and Fiscal Policy are being implemented in a booming economy. – Instruments seem to be operating. Exchange rate buffers most of the shock but interest rate increase should guarantee inflation on target. Fiscal policy must maintain debt stability. – “Sudden stop” is very tough for any regime. 22