Monetary Policy and Long-Term Real Rates in Brazil/Politica Monetaria e Taxa de Juros Real de Longo no Brasil.
| Autor | Filho, Adonias Evaristo da Costa |
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Introduction
This paper studies the reaction of long-term real interest rates to monetary policy in Brazil. More specifically, it investigates whether very long-term real rates are affected by monetary policy, improving the knowledge about how monetary policy affects Brazilian economy.
The question adressed in this paper has a long tradition in the history of economic thought, expressed in the debate between classical and Keynesians views of the way interest rates are determined.
Classical economists believed that the real rate of the economy in the long run was determined by real fundamentals, like productivity, intertemporal preferences and demographics. Over sufficient long horizons, when prices adjust, the real rate should not be affected by monetary factors, but rather by the real forces of the economy (Humphrey, 1983). Central banks therefore cannot permanently affect the equilibrium real rate of the economy, to which the economy shall return once short term frictions and cyclical factors dissipate. That rate was assumed to be stable and slow moving.
The monetary mechanism involved a unique relationship between the rates of interest, profit, growth and inflation, with firms demanding funds for investment until the real rate equates the marginal productivity of new capital. According to this mecanism, proposed by Wicksell (1898), if the money rate of interest was below from the natural rate, investment and growth would be stimulated. Eventually aggregate demand would be above potential, and inflation would rise. The opposite would happen if the money market interest rate exceeded the natural rate. The two-rate doctrine, in which inflation steems from the divergence of the market and the natural rate of interest, is described more detailed in Humphrey (1975), and is the basis for Wicksell's policy rule that the central bank can achieve price stability by trying to keep the market rate in line with the natural rate.
As Thornton (2012) put it, classical economists believed that "the" (real) interest rate acted as the level of the term structure, and could be defined as a long-term real rate determined by real fundamentals independent of monetary policy. Although unobservable, the equilibrium real long-term rate can be estimated as an average of the observed longterm real rate over a long period of time.
From an yield curve perspective, the classical view implies that the natural rate of interest plays the role of a gravity centre, or magnetic force for market rates. The long run real equilibrium rate of the economy would then attract market rates as a gravity centre (De-Juan, 2007). The classical theory assumes that the term structure of interest rates is anchored by the long-term real rate, in contrast with the expectation hypothesis, in which the term structure is anchored by the short-term rate, and long-term rates are determined by expectations of the future short-term rate (Thornton, 2012). Empirical failures of the expectation hypothesis would be a sign that the data supports the classical theory (1).
In opposition to the classical economists, Post-Keynesians hold the view that the interest rate is essentially a monetary phenomenon, which can be influenced by the central bank. Long-term rates can be computed as a multiple of the policy rate set by the central bank, with long rates determined as a mark-up over the policy rate (De-Juan, 2007). This markup is supposed to be high enough to cover banking costs and the general rate of profit. Post-Keynesians developed the concept of conventional rate of interest, the rate that has dominated in the near past and people expect to prevail in the foreseeable future. According to this view, the central bank can manage long-term rates in a way that over sufficient long periods, they attain the status of conventional. The only requirement is that the policy persists long enough to convince people that the economy has entered in a new financial scenario (De-Juan, 2007). Central banks therefore should try to keep the policy rate as low and stable as possible.
Less extreme than the (post) Keynesian view, Neo-Keynesians reject the notion of an equilibrium level of interest rate to which market rates would return, although not the notion of a natural rate of interest. Central banks have leverage over the short term real interest rates due to sticky prices, and by controlling the short-term real rate, they also influence longterm rates, since these are essentially determined by the short term rate, up to a risk premium. The ability to affect long-term rates is very important for the transmission channel of monetary policy, since spending and investment decisions depend not only on overnight interest rates, but rather on the whole path of expected interest rates. As Woodford (2003) explains:
"The effectiveness of changes in central-bank targets for overnight rates in affecting spending decisions (and hence ultimaly pricing and employment decisions) is wholly dependent upon the impact of such actions upon other financial-market prices, such as longer-term interest rates, equity prices, and exchange rates. These are plausibly linked, through arbitrage relations, to the short-term interest rates most directly affected by central-bank actions." (p. 16)
"Thus the ability of central banks to influence expenditure, and hence pricing, decisions, is critically dependent upon their ability to influence market expectations regarding the future path of overnight interest rates, and not merely their current level." (p. 16)
"The difference is that there is no inherent "equilibrium" level of interest rates to which the market would tend in the absence of central-bank intervention and against which the central bank must therefore exert a significant countervailing force in order to achieve a given operating target." (33-34)
"Moreover, determination of the overnight interest rate would also have to imply determination of the equilibrium overnight holding return on longer-lived securities, up to a correction for risk; and so determination of the expected future path of overnight interest rates would essentially determine longer-term interest rates."(36-37)
New-Keynesians therefore emphasize the role of expectations management for the determination of long-term rates and the effectiveness of monetary policy, since in their...
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