Optimal rules for monetary policy in Brazil

This paper presents optimal rules for monetary policy in Brazil derived from a backward looking expectation model consisting of a Keynesian IS function and an Augmented Phillips Curve (ISAS). The IS function displays'a high sensitivity of aggregate demand to the real interest rate and the Phillips Curve is accelerationist. The optimal monetary rules show low interest rate volatility with reaction coefficients lower than the ones suggested by Taylor (1993a,b). Reaction functions estimated through ADL and SUR models suggest that monetary policy has not been optimal and has aimed to product rather than inflation stabilization.

Optimal-state-dependent rules, credibility, and inflationary inertia

This paper examines the output losses caused by disinflation and the role of credibility in a model where pricing mIes are optimal and individual prices are rigid. Individual nominal rigidity is modeled as resulting from menu costs. The interaction between optimal pricing mIes and credibility is essential in determining the inflationary inertia. A continued period of high inflation generates an asymmetric distribution of price deviations, with more prices that are substantially lower than their desired leveIs than prices that are substantially higher than the optimal ones. When disinflation is not credible, inflationary inertia is engendered by this asymmetry: idiosyncratic shocks trigger more upward than downward adjustments. A perfect1y credible disinflation causes an immediate change of pricing rules which, by rendering the price deviation distribution less asymmetric, practically annihilates inflationary inertia. An implication of our model is that stabilization may be sucessful even when credibility is low, provided that it is preceded by a mechanism of price alignment. We also develop an analytical framework for analyzing imperfect credibility cases.

Dual resource transfers and interruption in external debt service

Externai debt service requires a dual resource transfer. Trade surpluses have to be generated in order to make foreign exchange revenues available for debt repayment. In addition, with developing countries' externai debt being largely a public liability, debt service requires that resources can be effectively transferred from the private to the public sector. This paper derives a statistical model for dealing with dual constraints in the presence of binary dependent variables and applies it to the dual resource transfer problem. The results from the estimation of the model for a sample of 31 middle-income developing countries in the period of 1980 to 1990, strongly support the hypothesis that both externai and fiscal constraints are important in explaining externai debt service disruptions.

Comments on public debt indexation and denomination, the case of Brazil

In this work I analyze the model proposed by Goldfajn (2000) to study the choice of the denomination of the public debt. Some potential shortcmomings of the mo dei in explaining the data are discussed. Measures of the overestimation of the welfare gains of reducing distortions from taxation, under the model's simplified time frame, are also provided. Assuming a time-preference parameter of 0.9, for instance, welfare gains associated with a hedge to the debt that reduces to half a once-for-all 20o/o-of-GDP shock to governemnt spending run around 1.43% of GDP under the no-tax-smoothing structure of the model. Under a Ramsey allocation, though, welfare gains amount to just around 0.05% of GDP.

Financial distress as a collapse of incentive scheme

This paper explaina why workers lack motivation near bankruptcy, why they tend to leave companies in financiai distreas, and why thoae who remam require higher compensation. Theae indirect costa of financiai diatresa adie becauae the optimal combination of debt and incentive achem.ea, deaigned to minimize agency costa, ends up underpaying managers when there ia a bankruptcy threat. The paper a1so providea new empirica1 implications on the intera.ction between financiai reatructuring and changea in managerial compensation. Theae predictions are supported by the findings of Gilson and Vetsuypens (1992).

Optimal exchange rate policy, optimal incomplete taxation and business cycles

Implementation and collapse of exchange rate pegging schemes are recur- rent events. A currency crisis (pegging) is usually followed by an economic downturn (boom). This essay explains why a benevolent government should pursue Þscal and monetary policies that lead to those recurrent currency crises and subsequent periods of pegging. It is shown that the optimal policy induces a competitive equilibrium that displays a boom in periods of below average de- valuation and a recession in periods of above average devaluation. A currency crisis (pegging) can be understood as an optimal policy answer to a recession (boom).

The optimality of the Friedman rule when some distorting taxes are exogenous

This paper investigates the optimality of the Friedman rule in a two-sector small open economy. That policy prescription is found to be a necessary condition for Pareto efficiency. If a planner can select all conceivable distorting taxes, then, for some initial values of public debt, money balances and foreign assets, it is possible to decentralize a Pareto efficient allocation. If the planner can select only some of these tax rates, then second-best policies may also satisfy the Friedman rule. However, this last result depends on the set of tax instruments the planner can choose from.

Sovereign debt with adverse selection : a quantitative approach

We construct a dynamic equilibrium model to quantitatively study sovereign debt with contingent services and country risk spreads such that the benefits of defaulting are tempered by higher interest rates in the future. For a wide range of parameters, the only equilibrium of the model is one in which the sovereign defaults in all states, unless defaulting incurs additional costs. Due to the adverse selection problem, some countries choose to delay default in order to reduce reputation loss. Although equilibria with no default imply in greater welfare levels, they are not sustainable in the highly indebted and volatile countries.

A risk management approach to emerging market's sovereign debt sustainability with an application to Brazilian data

In this paper we study the question of debt sustainability from a risk management perspective. The debt accumulation equation for any country involves variables that are stochastic and closely intertwined. When these aspects are taken into consideration the notion of debt sustainability is expanded to studying the stochastic properties of the debt dynamics. We illustrate the methodology by studying the Brazilian case. We find that even though the debt could be sustainable in the absence of risk, there are paths in which it is clearly unsustainable. Furthermore, we show that properties of the debt dynamics are closely related to the spreads on sovereign dollar denominated debt.

Informational spillovers in the pre-1914 London sovereign debt market

We document a novel type of international financial contagion whose driving force is shared financial intermediation. In the London peripheral sovereign debt market during pre-1914 period financial intermediation played a major informational role to investors, most likely because of the absence of international monitoring agencies and the substantial agency costs. Using two events of financial distress – the Brazilian Funding Loan of 1898 and the Greek Funding Loan of 1893 – as quasi-natural experiments, we document that, following the crises, the bond prices of countries with no meaningful economic links to the distressed countries, but shared the same financial intermediary, suffered a reduction relative to the rest of the market. This result is true for the mean, median and the whole distribution of bond prices, and robust to an extensive sensitivity analysis. We interpret it as evidence that the identity of the financial intermediary was informative, i.e, investors extracted information about the soundness of a debtor based on the existence of financial relationships. This spillover, informational in essence, arises as the flip-side of the relational lending coin: contagion arises for the same reason why relational finance, in this case, underwriting, helps alleviate informational and incentive problems.

Inglorious revolution : sovereign debt, tropical credibility, and financial underdevelopment in imperial Brazil

In 1824 the creation of institutions that constrained the monarch’s ability to unilaterally tax, spend, and debase the currency put Brazil on a path toward a revolution in public finance, roughly analogous to the financial consequences of England’s Glorious Revolution. This credible commitment to honor sovereign debt resulted in successful long-term funded borrowing at home and abroad from the 1820s through the 1880s that was unrivalled in Latin America. Some domestic bonds, denominated in the home currency and bearing exchange clauses, eventually circulated in European financial markets. The share of total debt accounted for by long-term funded issues grew, and domestic debt came to dominate foreign debt. Sovereign debt yields fell over time in London and Rio de Janeiro, and the cost of new borrowing declined on average. The market’s assessment of the probability of default tended to decrease. Imperial Brazil enjoyed favorable conditions for borrowing, and escaped the strong form of “original sin” stressed by recent work on sovereign debt. The development of vibrant private financial markets did not, however, follow from the enhanced credibility of government debt. Private finance in Imperial Brazil suffered from politicized market interventions that undermined the development of domestic capital markets. Private interest rates remained high, entry into commercial banking was heavily restricted, and limited-liability joint-stock companies were tightly controlled. The Brazilian case provides a powerful counterexample to the general proposition of North and Weingast that institutional changes that credibly commit the government to honor its obligations necessarily promote the development of private finance. The very institutions that enhanced the credibility of sovereign debt permitted the systematic repression of private financial development. In terms of its consequences for domestic capital markets, the liberal Constitution of 1824 represented an “inglorious” revolution.

The marginal cost of funds from public sector borrowing

An expression for the welfare cost of a marginal increase in the public debt is derived using a simple AK endogenous growth model. This measure of the marginal cost of public funds (MCF) can be interpreted as the marginal benefit-cost ratio that a debtfinanced public project needs in order to generate a net social gain. The model predicts an increase in the public debt ratio will have little effect on the optimal public expenditure ratio and that most of the adjustment will occur on the tax side of the budget.

Optimal growth in a two-sector model without discounting: a geometric investigation

We characterize optimal policy in a two-sector growth model with xed coeÆcients and with no discounting. The model is a specialization to a single type of machine of a general vintage capital model originally formulated by Robinson, Solow and Srinivasan, and its simplicity is not mirrored in its rich dynamics, and which seem to have been missed in earlier work. Our results are obtained by viewing the model as a specific instance of the general theory of resource allocation as initiated originally by Ramsey and von Neumann and brought to completion by McKenzie. In addition to the more recent literature on chaotic dynamics, we relate our results to the older literature on optimal growth with one state variable: speci cally, to the one-sector setting of Ramsey, Cass and Koopmans, as well as to the two-sector setting of Srinivasan and Uzawa. The analysis is purely geometric, and from a methodological point of view, our work can be seen as an argument, at least in part, for the rehabilitation of geometric methods as an engine of analysis.

The time consistency of the Friedman rule

We consider the problem of time consistency of the Ramsey monetary and fiscal policies in an economy without capital. Following Lucas and Stokey (1983) we allow the government at date t to leave its successor at t + 1 a profile of real and nominal debt of all maturities, as a way to influence its decisions. We show that the Ramsey policies are time consistent if and only if the Friedman rule is the optimal Ramsey policy.