The document discusses Brazil's central bank and the issue of its independence. It notes that while interest rates in Brazil have fallen substantially over the past decade, the benchmark interest rate remains higher than peers due to doubts about the inflation-targeting regime given the central bank is not independent. The document examines arguments for and against central bank independence, noting that while independence may enhance credibility, the track record of inflation targeting is mixed for both independent and non-independent central banks in Latin America. It concludes that the impact of Brazil's lack of central bank independence on interest rates is complex with no clear answer.

1. TRENDS + VIEWS
Brazil’s central bank and the issue of independence – October 2013
EXECUTIVE SUMMARY
The benchmark interest rate in Brazil recently hit a record low, and
the current real rate of approximately 3% is well below the historical
average.
As the Banco Central do Brasil is not an independent central bank,
there are bound to be concerns about political interference in its
decision making.
Policy makers appear to be accommodating a rate of inflation above the target, albeit still
low relative to Brazil’s prior experience and many other large Emerging Markets countries.
Longer-term interest rates are higher than regional peers, due to doubts about the inflationtargeting regime.
Independence is not a necessary precondition for meeting inflation targets, and the recent
history shows a mixed performance for independent central banks.
Nonetheless, home buyers have access to mortgage rates, that on an inflation-adjusted
basis, are lower than most other countries in Latin America.
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2. TRENDS + VIEWS
Brazil’s central bank and the issue of independence – October 2013
Interest rates in Brazil have fallen substantially over
its Latin American peers – even though the sovereign
the last decade, and indeed this has been a major
rating on Brazilian debt is similar to a country such as
contributor to price appreciation of real estate in recent
Colombia, whose benchmark rate stands at 3.25%, 625
years. Mortgage rates, in inflation-adjusted terms, are
basis points below the SELIC.
comparable to those in other major economies of the
There are a number of explanations for the elevated
region, if not lower, which has pushed up the stock
of mortgages as a share of GDP to a record high of
7.8%, according to the most recent data. The stock
of mortgages is growing at more than 30% year over
year, thanks in part to more reasonable financing rates,
level of Brazilian rates. Economists cite reasons such as:
• he relatively lax fiscal policy in Brazil, with the most
T
recent headline number showing a 3.1% of GDP
deficit over the last twelve months.
while banks are also increasingly prioritizing housing
• Brazil’s relatively recent history of hyperinflation, as
products. The ability of policy makers in recent years to
inflation was several thousand percent, on a year
create a lower and more stable inflation environment
over year basis, as recently as 1994.
allowed for the issuance of longer duration mortgages,
which
naturally
reduced
monthly
payments
and
improved affordability. Controlled inflation has also
been supportive of increasing real wages, which in
turn encouraged housing demand. More predictable
inflation rates in Brazil also allowed the sovereign
government and corporations to finance themselves
in local currency, for longer durations. This healthy
combination of factors contributed to Brazil’s sovereign
system, which can distort monetary policy and
financial conditions.
•
Inflation inertia caused by still-significant amounts
of indexation in the economy, which is a legacy of
Brazil’s hyperinflation past. One example of this is the
setting of the minimum wage, which is based on a
prior year’s inflation rate.
• The relatively high 4.5% inflation target in Brazil,
debt reaching investment grade status in 2008.
However, despite the decline in borrowing rates, the
benchmark interest rate in Brazil is still, by far, the
highest
• The large role of state-held banks in the financial
among
which is above those in Latin American peers such as
Colombia, Mexico, and Peru, where the targets range
from 2%-3%.
America’s
Another oft mentioned reason for elevated rates in
economies.
Brazil is the lack of independence of Brazil’s central
the
bank. Central bank independence is a feature in many
of
of Brazil’s peers, such as Chile, Colombia, Mexico, and
interest rates in Brazil
Peru. However, establishing true legal/constitutionally
has been a central
mandated independence of the Banco Central do Brasil
topic for observers of
(BCB) has never gained political traction and is not on
the country’s economy for years. While the benchmark
the current political agenda. Whether or not this lack
SELIC rate, currently at 9.5%, is well below the historical
of independence influences the level of interest rates
average (as recently as 2003, the SELIC was 26.5%),
in Brazil, and to what degree, is a complex and heated
and indeed earlier this year, the SELIC hit 7.25%, an all-
topic.
With a benchmark
rate in single digits,
the SELIC is very
low by historical
standards.
Latin
major
Explaining
elevated
level
time low, Brazil’s borrowing rates are still higher than in
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3. TRENDS + VIEWS
Brazil’s central bank and the issue of independence – October 2013
To start, in theory, independent central banks can
the central bank is essentially an arm of the executive
make monetary policy decisions based on their actual
branch, and carries out monetary policy in accordance
mandate, whether that is an inflation target or some
with the political goals of an administration. Argentina
other metric or goal. Decisions can be taken, presumably,
would be an example, where the Central Bank finances
without worry that politicians will interfere in the policy
the Treasury, and its fiscal deficit at the behest of the
making process or feel apt to remove a central bank
Kirchner government, even when this policy mix leads
governor that makes a decision that could compromise
to major inflationary consequences.
short-term economic outcomes.
The mission of the Banco Central do Brasil is “to ensure
Central banks that lack independence are more at risk
the stability of the currency’s purchasing power and a
of political pressure, which undermine their ability
solid
to implement policy decisions based on mandates
financial
and objectives, such as inflation targeting. Politicians
through an inflation
presumably prefer monetary policy to be less restrictive
targeting
as a means of encouraging lending, consumption, and
which began in 1999.1
economic growth. Most standing governments prefer,
In Brazil’s case, the
all things equal, a lower interest rate to a higher one.
current
There are essentially three models of arrangements
target is 4.5%, with
for central banks. The first is one where the central
bank is legally and constitutionally independent, where
decisions can be taken without fear of major political
repercussions. Within Latin America, Chile stands out
in this regard, for example. The second model is one
where the central bank is de facto independent, but
subject to risk of government intervention; Brazil fits
this category. Finally the third category is one where
CHART 1: REAL INTEREST RATES IN BRAZIL (SELIC – ACTUAL INFLATION)
a
and
efficient
system,
”
system,
inflation
tolerance
During the Lula
government,
the central bank
operated a very
disciplined
approach to
monetary policy.
band
of 2% to each side
of this central target. Under a true inflation targeting
regime, the central bank would adjust the policy rate
in accordance with its expectations for future inflation,
and lower or raise the benchmark rate to enhance its
chances of achieving the target. However, in recent years
the track record of Brazil’s Central Bank in delivering
its inflation target has been less than stellar. The most
recent September reading on the benchmark IPCA index
showed an inflation rate of 5.9% for example, which was
15%
the first report in 2013 where year over year inflation
12%
was below 6%.
9%
Under the government of President Lula (2003-11), the
Central Bank appeared to enjoy functional independence,
6%
despite fears that Lula would intervene in its policy
3%
making. Indeed, after assuming office, then Central
Bank President Henrique Meirelles raised interest rates
0%
2000
2002
2004
2006
2008
2010
2012 2013
substantially in 2003 and kept the benchmark rate at or
Source: Bloomberg
1 Banco Central do Brasil website: www.bcb.gov.br
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4. TRENDS + VIEWS
Brazil’s central bank and the issue of independence – October 2013
above 26% for the first six months of the government.
case, as Europe’s sovereign debt crisis represented a
While this policy approach led to contracting economic
major economic headwind for Brazil and that Tombini,
activity, it showed that the administration was serious
by easing when he did, proved to be well ahead of his
about fighting inflation, resulting in a stabilized exchange
peers.
rate, which had weakened markedly in the months
Indeed, the current Board of the Central Bank has
leading up to the election. Inflation, which reached
17.2% in May 2003, fell to 5.2% by May 2004, helping
create the necessary conditions for an improvement in
business confidence in the years that followed. Longterm interest rates fell substantially, as the Central
Bank was viewed as being a strong inflation fighter,
and Meirelles was seen as holding a “hawkish” attitude
toward inflation, even with a left-of-center government
in office. In May 2007, inflation fell below 3%, and even
as late as 2009, inflation ended the year at 4.3%, below
the official target.
faced a challenging
backdrop
over
the
last 1-2 years, with a
challenging
external
environment, slower
than normal domestic
economic growth, but
an elevated inflation
rate.
Market participants
believe that the
central bank is not
necessarily targeting
the official goal of
4.5% inflation.
When growth
and inflation are both
low, the typical policy prescription is to ease. However,
When Dilma Rousseff took office in 2011, she appointed
when growth is low and inflation is high, a central bank
Alexandre Tombini, an experienced technocrat, as
cannot usually attack both problems simultaneously.
Central Bank Governor. However, under the present
Federal Reserve Chairman Paul Volcker faced facing
administration,
questioned
a similar low growth, high inflation quandary in
whether the Central Bank enjoys the same de facto
the late 1970s and early 1980s, and opted to tighten
independence that it enjoyed under Lula. Rousseff, who
policy dramatically, which sent the US economy into
holds an economics degree from the Federal University
a recession, but ultimately led to lowering inflation
of Rio Grande do Sul, is perceived by many observers to
and longer-term interest rates, setting the stage for
be more intrusive than Lula. These observers question
a subsequent impressive economic recovery in the
whether or not Rousseff might have pressured the BCB
United States. In Brazil, the Central Bank, until recently,
Board, pointing to BCB policy decisions that might
kept the policy rate at an all-time low, even with inflation
confirm their suspicions. For example, in October 2011,
well above its target. The BCB’s current policy mix of
even though the most recent report had showed IPCA
low interest rates in spite of high inflation in a slow
inflation above 7.3%, the monetary authority lowered
growth environment is compromising the Central
the SELIC rate by 50 basis points. This decision alarmed
Bank’s credibility as an inflation targeter and may result
some investors now concerned that the Central Bank
in longer-term interest rates, if markets perceive that the
might not be a true inflation targeter. Easing policy could
BCB might not be targeting 4.5% inflation, but perhaps a
have led to elevated inflation expectations moving well
higher rate, if not another metric (such as GDP growth).
above the upper limit of the target band’s range, and
Recently, with inflation becoming a more politically
some
investors
have
maybe even providing a sign of political intervention
in the Bank’s processes. However, others have also
argued that the BCB was particularly prescient in this
charged topic in Brazil, especially in the wake of the June
protests, which were ignited over the increase of bus
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OCTOBER 2013
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5. TRENDS + VIEWS
Brazil’s central bank and the issue of independence – October 2013
fares, the BCB has tightened policy in an effort to ward
growth, while more heterodox ones, such as Brazil’s
off any potential inflation spikes. Since April, the SELIC
Finance Minister, seem to think that allowing a bit more
rate has been lifted from 7.25% to 9.5%, with the market
inflation (via lax fiscal and monetary policy) contributes
looking for several more hikes in the near term. Indeed,
to stronger growth. The Taylor Rule indicates that the
interest rate markets price in another 50 basis points hike
policy rate should be increased in a rising inflation
at the November meeting, with several more 25 basis
environment, but the Central Bank in Brazil has not
points hikes to follow in early 2014. The recent moves
necessarily followed this model, and one can argue that
have especially important implications as Brazil heads
Brazil’s economy is now paying the cost, as inflation
into an election year. Recent comments from Central
expectations, even according to its own forecasts, are
Bank
Track record of
independent Latin
America central
banks in fighting
inflation is mixed.
Directors,
for
expected to remain well above the 4.5% target for the
example stating that
foreseeable future.2
there is much work
However, in spite of the arguments favoring more
for monetary policy
to do to curb inflation,
seemed to temporarily
lessen concerns that
government pressure
might be a factor behind the recent policy decisions in
Brazil. However, such doubts, due to the BCB’s penchant
for easing policy over the last couple years even as
inflation surged well above the target rate have already
been cast.
central bank independence, such independence is not
always a necessary condition to bring down longerterm interest rates, even though legally mandating
independence does enhance credibility. Where the
central bank does have legal independence, the track
record for achieving inflation goals has generally
been better, as countries such as Colombia and Chile
demonstrate, where inflation in each is currently below
their respective 3% targets. However, independence
is no guarantee of achieving an inflation target, as
The net result of these worries about central bank
the Mexico case shows, where inflation has remained
independence is that longer-term interest rates in Brazil
stubbornly above its 3% target. Indeed the track record
are presumably higher than in other countries in part
for the major Latin American central banks of meeting
because the market has some doubt about the inflation
their inflation targets is mixed. In the below chart, we
fighting resolve of the BCB. Indeed, longer-term rates
take the five major Latin American central banks, and
in Brazil are in the double digits, and the yield curve is
display the year over year inflation for each country at
steep, relative to many other large emerging markets.
the end of each calendar year, since 2003. We note that
The supposed “neutral” interest rate, i.e. the real
Brazil, whose central bank is not officially independent,
interest rate that neither stimulates nor restrains activity,
met its inflation target in three of the last ten years, for a
is also estimated to be higher in Brazil, at perhaps 4%,
success rate of 30%. Chile in contrast met its goal 60%
compared to around 2% in a country such as Colombia.
of the period, while Mexico – even with its independent
The inflation-growth tradeoff is a tricky one for policy
central bank – has not satisfied its inflation target once
makers. Orthodox economists argue that allowing
during this time frame.
more inflation does not necessarily result in more
If we extend the analysis however, we see that in years
2 The Taylor rule is a monetary-policy rule that stipulates how much the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions. The rule
is named after renowned economist John Taylor, currently a professor at Stanford University.
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6. TRENDS + VIEWS
Brazil’s central bank and the issue of independence – October 2013
where the Brazilian central bank missed its target,
to this question is uncertain. Brazil’s 6% inflation rate
the average ‘miss’ has been by 2.18%. Chile actually
actually compares favorably to other large EM countries
displayed the largest ‘misses,’ due to the commodity
such as South Africa, Indonesia and Turkey, all of which
price shock that impacted that small, open economy
have legislated central bank independence and are
in 2007-08. Since Chile imports nearly all of its oil, its
struggling with similar internal and external conditions.
inflation rate proved very susceptible to the move to
Some researchers have argued that the independence
$150/barrel in oil during that time frame. Meanwhile,
of the U.S. Federal Reserve has been eroded in recent
Mexico which never actually hit its 3% inflation target,
years, through its policy of quantitative easing, which is
showed the smallest average inflation ‘miss’ during the
a form of “cooperating with the Treasury and engaging
time frame examined.
in fiscal policy. 3 These outcomes could lead one to
”
If we go another step further, and look at the 2010-13 time
suggest that maybe central bank independence just
frame, which encapsulates the period of Dilma’s election
doesn’t matter as much as some economists perceive.
followed by her appointment of the current economic
In Brazil, while the BCB is not legally independent, it
policy leadership, we see that Brazil has missed on its
is important that the institution make strides toward
target in all four of these years (assuming that 2013
fulfilling its inflation-targeting mandate. Achieving
inflation is in line with the Bloomberg consensus
more credibility is a necessary condition toward
forecast of 6.2%). The average deviation from the 4.5%
reducing longer-term interest rates, which can unleash
target over this time frame has been 1.61%. Mexico and
even further demand for mortgages and other longer
Peru have been within 1% of their target on average,
duration financial products. Should mortgage rates
while Chile and Colombia have on average remained
fall to the mid-single digits as a result, as has occurred
below their 3% targets over this time frame.
in the developed world, the real estate market would
Is Brazil’s inability to meet its inflation target in recent
obviously feel the benefit.
years due to any change in the de facto independence of
We would further the notion that what matters more
the Central Bank? Indeed in recent years one can point
than independence is political will. Central bankers,
to a number of factors exogenous to monetary policy
whether they have true independence or not, need
that also contribute toward higher rate of inflation in
to have the political will to offset pressures that may
Brazil, including the 1) weakness of the real over the
come within government, the private sector or society
last 18 months; 2) lax fiscal policy; and 3) expansion of
at large, to manage monetary policy according to their
credit from state owned banks. When one adds other
mandate – whether that mandate be price stability or
factors that contribute to structural inflation such as the
some other goal.
high degree of indexation that still exists in the Brazilian
economy, as well as infrastructure and issues related
to red tape, one might conclude that the BCB’s job of
achieving its inflation target is especially difficult
Would an independent central bank have been able to
satisfy the 4.5% target under such conditions? The answer
3 John Taylor, “The Effectiveness of Central Bank Independence Versus Policy Rules. Stanford Institute for Economic Policy Research. January 2013.
”
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7. TRENDS + VIEWS
Brazil’s central bank and the issue of independence – October 2013
TABLE 1: TRACK RECORD OF INFLATION IN MAJOR LATIN AMERICAN COUNTRIES
INFLATION (%)
TARGET
(%)
BRAZIL
TARGET
SINCE
INDEPENDENT
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013E
4.5
4.5 since 2005*
No
9.3
7.6
5.7
3.1
4.5
5.9
4.3
5.9
6.5
5.8
6.2
CHILE
3
2000
Yes
1.1
2.4
3.7
2.6
7.8
7.1
-1.4
3.0
4.4
1.5
1.8
COLOMBIA
3
2002
Yes
6.5
5.5
4.9
4.5
5.7
7.7
2.0
3.2
3.7
2.4
2.4
MEXICO
3
2002
Yes
4.0
5.2
3.3
4.1
3.8
6.5
3.6
4.4
3.8
3.6
3.7
PERU
2
2002**
Yes
2.3
3.7
1.3
2.0
1.8
5.8
3.0
1.5
3.4
3.7
2.7
*Target was 5.5% + or - 2.5% in 2003-04.
Chile independent in 1989.
**Was 2.5%, lowered to 2% in 2007
Source: Bloomberg
TABLE 2: ABILITY OF LATIN AMERICAN COUNTRIES TO MEET INFLATION
TARGETS IS MIXED (2003-2012)
SUCCESS
RATE
IN YEARS MISSED
AVG. DEVIATION
2010-2013
AVG. DEVIATION
BRAZIL
30%
2.18%
1.61%
CHILE
60%
2.76%
-0.33%
COLOMBIA
20%
2.49%
-0.06%
MEXICO
0%
1.22%
0.87%
PERU
50%
1.61%
0.82%
Source: Jamestown Latin America calculations
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