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  • Monetary Policy and Inflation in Brazil (1975-2000): AVAR Estimation*

    Andre Minella**

    Summary: 1. Introduction; 2. Methodology; 3. Results; 4. Con-clusions.

    Keywords: monetary policy; ination; interest rate; money; Brazil.

    JEL codes: E31; E52.

    This paper investigates monetary policy and basic macroeconomicrelationships involving output, ination rate, interest rate, andmoney in Brazil. Based on a vector autoregressive (VAR) esti-mation, it compares three dierent periods: moderately-increasingination (19751985), high ination (19851994), and low ination(19942000). The main results are the following: monetary policyshocks have signicant eects on output; monetary policy shocksdo not induce a reduction in the ination rate in the rst two peri-ods, but there are indications that they have gained power to aectprices after the Real Plan was launched; monetary policy does notusually respond rapidly or actively to ination-rate and output in-novations; in the recent period, the interest rate responds intenselyto nancial crises; positive interest-rate shocks are accompanied bya decline in money in all the three periods; the degree of inationpersistence is substantially lower in the recent period.

    Este artigo examina a poltica monetaria e relacoes macroecono-micas basicas envolvendo produto, inacao, taxa de juros e moedano Brasil. Baseando-se em uma estimativa de um vetor auto-regressivo (VAR), comparam-se tres perodos: inacao moderada-mente crescente (19751985), alta inacao (19851994) e baixainacao (19942000). Os principais resultados sao os seguintes:choques na poltica monetaria tem efeitos signicativos no produto;choques na poltica monetaria nao induzem uma reducao na taxa deinacao nos dois primeiros perodos, mas ha indicacoes de que eles

    *This paper was received in Dec. 2001 and approved in Aug. 2002. I am grateful to MarkGertler, Ali Hakan Kara, Kenneth Kuttner and two anonymous referees for their helpful com-ments and suggestions. All remaining errors are my responsibility. Financial support from theCentral Bank of Brazil and CAPES is gratefully acknowledged. The views expressed are thoseof the author and not necessarily those of the Central Bank of Brazil or its members. E-mail:andre.minella@bcb.gov.br.

    **Research Department, Central Bank of Brazil.

    RBE Rio de Janeiro 57(3):605-635 JUL/SET 2003

  • 606 Andre Minella

    aumentaram seu poder de afetar precos depois que o Plano Real foiimplementado; a poltica monetaria geralmente nao responde ativaou rapidamente frente a choques na taxa de inacao e no produto;no perodo recente, a taxa de juros responde intensamente a crisesnanceiras; choques positivos na taxa de juros sao acompanhadospor um declnio na quantidade de moeda em todos os tres perodos;o grau de persistencia inacionaria e signicativamente menor noperodo recente.

    1. Introduction

    This paper investigates monetary policy and basic macroeconomic relation-ships involving output, ination rate, interest rate, and money in Brazil. Based ona vector autoregressive (VAR) estimation, the paper addresses the following ques-tions: do monetary policy shocks have real eects?; do monetary policy shocksaect ination rate?; what is the reaction of monetary policy to ination-rate,output, and nancial shocks?; is ination rate persistent?; what is the relationbetween money and interest rate?

    Furthermore, the objective is to compare these relationships across dierentperiods. Because of the limited availability of data, the sample estimation goesfrom 1975 to 2000. The ination rate, measured as percentage variation per month,and its rst dierence are presented in gure 1. Based on the behavior of theination rate and stabilization policies, the macroeconomic context in Brazil canbe divided into three periods:

    Moderately-increasing ination (19751985). Ination rate was increasing,but at a slower rate than the prevailing in the following nine years. There wasno stabilization program that produced an abrupt reduction in the inationrate;

    High ination (19851994). Ination rate grew at a fast rate. There wereve stabilization programs, usually involving price freeze without previousannouncement. Their success were just momentary: the ination rate fellabruptly, but sooner or later it increased again;

    Low ination (1994). The Real Plan, launched in July 1994, has achieveda substantial and lasting reduction in the ination rate.

  • Monetary Policy and Inflation in Brazil (1975-2000): A VAR Estimation 607

    Figure 1

    Selected Variables: 1975-2000 (Monthly Data)Industrial Production Index (Y) - Log Level

    log

    leve

    l

    1975 1978 1981 1984 1987 1990 1993 1996 1999420

    440

    460

    480

    500

    First Difference of Y

    %

    1975 1978 1981 1984 1987 1990 1993 1996 1999-30

    -20

    -10

    0

    10

    20

    30

    Inflation Rate - IGP-DI (INF)

    % p

    er m

    on

    th

    1975 1978 1981 1984 1987 1990 1993 1996 1999-12

    0

    12

    24

    36

    48

    60

    72

    84

    First Difference of INF

    % p

    er m

    on

    th

    1975 1978 1981 1984 1987 1990 1993 1996 1999-75

    -50

    -25

    0

    25

    Nominal Interest Rate (INT)

    % p

    er m

    on

    th

    1975 1978 1981 1984 1987 1990 1993 1996 19990

    10

    20

    30

    40

    50

    60

    70

    80

    90

    First Difference of INT

    % p

    er m

    on

    th

    1975 1978 1981 1984 1987 1990 1993 1996 1999-50

    -40

    -30

    -20

    -10

    0

    10

    20

    Growth Rate of M1 (GRM1)

    % p

    er m

    on

    th

    1975 1978 1981 1984 1987 1990 1993 1996 1999-25

    0

    25

    50

    75

    100

    125

    First Difference of GRM1

    % p

    er m

    on

    th

    1975 1978 1981 1984 1987 1990 1993 1996 1999-100

    -80

    -60

    -40

    -20

    0

    20

    40

    60

    In particular, the change from a high to a low-ination environment is expectedto be accompanied by an increase in the eectiveness of monetary policy. Onereason is the reduction in the degree of ination persistence in the recent period,which is veried by the estimation in this paper.1

    For the OECD countries, the literature that investigates monetary policy andmacroeconomic relationships using a VAR estimation is vast.2 For Brazil, in con-trast, only more recently the VAR approach has been employed. For the periods

    1Other factors that would increase the eectiveness of monetary policy are stressed by Lopes(1997): a lower ination-rate volatility premium, an expected longer maturity of assets thatwould raise the wealth eect of an increase in the interest rate, the expansion in credit that hasaccompanied the stabilization, and the adoption of a oating exchange-rate regime expandingthe exchange-rate channel.

    2See, for example, Christiano et al. (1996, 1999), Bernanke et al. (1997), Bernanke and Mihov(1998b,a), Sims (1992), Blanchard (1989), Friedman and Kuttner (1992), Friedman (1996), Gal(1992), and Kim (1999).

  • 608 Andre Minella

    before the recent stabilization program, Pastore (1995, 1997) has found passivenessof money supply to the ination rate, and high degree of ination persistence.3 Interms of comparison across periods, Fiorencio and Moreira (1999) have concludedthat, during 19821994, monetary policy did not practically aect unemploymentand price level, whereas, for 19941998, positive interest-rate shocks increasedunemployment and decreased price level. For 19952000, Rabanal and Schwartz(2001) have found a negative response of output and money to interest-rate shocks.Nevertheless, I consider that it is necessary an investigation that covers a largespan, addresses all the questions previously mentioned, and compares results acrossthe three dierent periods.

    In spite of the instability of the Brazilian economy, several important resultsemerge from the estimations in this paper. First, monetary policy shocks haveimportant real eects on the economy. Positive shocks to the interest rate lead toa decline in output in all the three periods analyzed. The eect seems to be morepronounced after the Real Plan was launched. Second, despite the real eects,monetary policy shocks do not generate a reduction in the ination rate duringthe rst two periods. For the Real Plan period, however, there is some evidencethat monetary policy has gained power to curb ination, although the results arenot conclusive. Third, regarding the reaction of monetary policy, the interest ratedoes not respond actively or at least rapidly to ination-rate innovations: the re-sponse of the nominal interest rate, in the rst two months, is smaller than therise in the ination rate in all the three periods analyzed. Similarly, the interestrate does not react to stabilize output. In the Real Plan period, monetary policyresponds strongly to nancial crises. Fourth, the degree of ination persistencehas clearly decreased in the recent period. Fifth, a positive interest-rate innova-tion is accompanied by a decline in money in all the periods. In fact, there issome evidence of a negative correlation between money supply and interest rate.Furthermore, ination-rate innovations induce a decline in the real money levels.The results are also consistent with the fact that the Central Bank targets theinterest rate instead of M1.

    Section 2 deals with the methodology used for the estimation, and section 3presents the results. A nal section concludes the paper.

    2. Methodology

    The paper considers the following dynamic model:3He has estimated an error correction model for 1944-1985 that included only the ination

    rate and a monetary aggregate. His Granger causality tests have also involved 19861994.

  • Monetary Policy and Inflat