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Very High Interest Rates and the Cousin Risks: Brazil During the Real Plan

Very High Interest Rates and the Cousin Risks: Brazil During the Real Plan

Chapter:
(p.107) 3 Very High Interest Rates and the Cousin Risks: Brazil During the Real Plan
Source:
Latin American Macroeconomic Reforms
Author(s):
Márcio G. P. GarciaTatiana Didier
Publisher:
University of Chicago Press
DOI:10.7208/chicago/9780226302683.003.0004

This chapter examines the determinants of interest rates in Brazil. Based on the interest parity conditions, it considers the behavior of so-called cousin risks: the currency risk and the country (Brazil) risk. These two risks are fundamental in the determination of a floor for the domestic interest rate, and reducing them is the main objective if one aims at achieving interest rates compatible with sustained economic growth. The chapter is organized as follows. Section 3.2 deals with theoretical derivations as well as measurement and estimation issues pertaining to country and currency risks. Section 3.3 applies the developments of Section 3.2 to generate several country-risk measures and one currency-risk estimate. Section 3.4 uses the country- and currency-risk measures to analyze (decompose) the domestic interest rate. Finally, Section 3.5 discusses the determinants of the very high real interest rates in Brazil, as well as the policy actions that should be taken in order to achieve lower real interest rates without compromising inflation stability, thereby fostering higher growth.

Keywords:   domestic interest rates, currency risk, country risk, real interest rates, monetary policy

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