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Unlike common wisdom, sterilized FX purchases under inflation targeting, i.e., those that keep the interest rate at the level targeted by the central bank, generally increase aggregate demand. We resort to a simple model with a credit channel to argue that FX purchases, by funding bank credit, end up increasing aggregate and money demand, while expanding loans and reducing the loan interest rate. Therefore, restoring the interest rate to the level previous to the FX purchase may not be sufficient to avoid the expansionary effect; the new money market equilibrium, at the same interest rate, will entail a larger money supply, higher output and larger money demand. Recent Brazilian evidence is reviewed, showing that this effect may be empirically relevant. If this is the case, inflation targeters may have another reason to be concerned when conducting FX sterilized interventions, besides their high cost and controversial effectiveness in preventing nominal appreciation. FX sterilized purchases may not only fail to prevent nominal appreciation, but also boost activity and inflation, thereby appreciating the real exchange rate.

Despite the large size of the Brazilian debt market, as well the large diversity of its bonds, the picture that emerges is of a market that has not yet completed its transition from the role it performed during the megainflation years, namely that of providing a liquid asset that provided positive real returns. This unfinished transition is currently placing the market under severe stress, as fears of a possible default from the next administration grow larger. This paper analyzes several aspects pertaining to the management of the domestic public debt. The causes for the extremely large and fast growth of the domestic public debt during the seven-year period that President Cardoso are discussed in Section 2. The main culprit is the very high and risky interest rate, with the recognition of old debts (hidden liabilities and state debt renegotiation) coming in second. Section 3 computes Value at Risk and Cash Flow at Risk measures for the domestic public debt. These risk measures show that the current composition of the public debt is very risky. The rollover risk is introduced in a mean-variance framework in Section 4, and the maturity structure evolution is discussed. The increased riskness was the cost to improve the maturity structure. Section 5 discusses a few issues pertaining to the overlap between debt management and monetary policy. Finally, Section 6 wraps up with policy discussion and policy recommendations.

The hope that lower real interest rates and higher growth would follow the floatation of the currency was in large measure frustrated. Two international liquidity crises, caused by the reversal of capital flows, hit in 2001 and 2002. These crises were associated with higher interest rates, lower economic activity and higher inflation. Therefore, the name exchange-rate stagflation seems to characterize the essence of the phenomenon. A stylized model, due to Caballero and Krishnamurthy [2002], was used to explain the events. The main characteristic of the model is that domestic investment depends on the aggregate international liquidity of the economy, which is a limiting factor. During a liquidity crisis, the amount of liquidity is reduced, and the economy falls in recession. Neither the fiscal authority nor the monetary authority can reflate the economy by increasing government expenditures or the money supply. The bulk of the difficulties Brazil is currently facing derives from the uncertainty associated with the course of the future economic policy to be followed by the new administration, and to the sustainability of the public debt. To avert a painful default, real interest rates must fall and sustained growth must resume. To increase the chances of success, several policy measures are suggested: · To increase the exportability of the economy; · To increase the fiscal effort, in order to help dispel the doubts over the sustainability of the public debt; · To increase the credibility of the monetary authority, by conferring instrument independence to the Brazilian Central Bank; and · To resume the debt management efforts to lengthen the debt profile while reducing the indexation to the exchange rate and to the Selic short term rate, by making larger user of inflation-linked bonds. When and if the current international liquidity crisis is overcome, the above measures will help Brazil to lower the real interest rates and achieve sustained growth.

RESUMO Diferentemente dos ciclos de crescimento anteriores no Brasil, o novo que completará o plano de estabilização do Real não pode mais contar com o Estado como o principal financiador e responsável pelos investimentos em infraestrutura. Isso representa uma tendência mundial, que originou o financiamento do projeto, uma maneira de financiar pesados investimentos projetados para viabilizar a parceria público-privada. O financiamento do projeto separa o risco firme do risco comercial e projeta arranjos financeiros específicos para cada projeto de investimento. No Brasil, agora que a lei que regula a concessão ao setor privado foi promulgada e o programa de privatização foi acelerado, o financiamento do projeto provavelmente constituirá o principal procedimento de financiamento para investimentos em infraestrutura. Para que o financiamento do projeto funcione, o ambiente regulatório deve ser claro e os contratos devem ter credibilidade, impedindo que o setor público seja esquecido, forçado a resgatar projetos insolventes. É apresentada uma nova proposta para o sistema BNDES - um seguro contra o risco macroeconômico nas operações de crédito. Esta proposta visa a construção de um mercado de crédito de longo prazo no Brasil.

RESUMO Desde o início do Plano Real, o governo tem recorrido a depósitos compulsórios muito mais elevados sobre o passivo dos bancos, bem como à criação de depósitos compulsórios sobre crédito (ativo de um banco) na tentativa de restringir a expansão dos agregados monetários e do crédito. A intenção da política estava certa, embora o desenho do perfil dos requisitos de reservas, ou seja, a estrutura relativa dos requisitos de reservas sobre os passivos do banco diferente, fosse falho. Isso ocorre porque há uma exigência de reserva muito alta (inicialmente 100% marginal) sobre os depósitos à vista, que é o passivo que normalmente cresce mais quando as altas inflações diminuem. Desde o início de 1995, as mudanças tributárias tornaram lucrativa a transferência até mesmo de fundos de muito curto prazo de depósitos à vista para fundos mútuos de curto prazo. Além disso, quando essa transferência é realizada, o depósito compulsório geral cai substancialmente. A principal recomendação de política é usar tanto o perfil dos compulsórios quanto a estrutura tributária de modo que a riqueza financeira agregada seja distribuída entre seus diversos componentes de forma compatível com a baixa inflação. Isso evitará futuras realocações de carteira, aumentando a eficácia da política monetária.

ABSTRACT This paper examines the recent evolution of the Brazilian public domestic debt and interprets it in light of the confidence crisis literature. The analysis of the recent developments in the Brazilian public domestic debt market shows that the likelihood of a default must not be assessed only using simple summary aggregate measures of public domestic debt size and maturity, but must also consider other structural aspects. Our analysis emphasizes the two main pillars of the Brazilian public domestic debt market: home-bias and the role of the banking sector in intermediating the debt. Evidence from yields of a "perfectly" indexed bond shows that the rollover premium was very small when the devaluation occurred, and is still fairly small by October, 1999, indicating that the rollover of the public domestic debt is not, so far, a serious problem. Positive prospects for the public domestic debt market will depend, however, on the Brazilian government maintaining the current fiscal austerity program.

ABSTRACT This paper examines the recent evolution of the Brazilian public domestic debt and interprets it in light of the confidence crisis literature. The analysis of the recent developments in the Brazilian public domestic debt market shows that the likelihood of a default must not be assessed only using simple summary aggregate measures of public domestic debt size and maturity, but must also consider other structural aspects. Our analysis emphasizes the two main pillars of the Brazilian public domestic debt market: home-bias and the role of the banking sector in intermediating the debt. Evidence from yields of a "perfectly" indexed bond shows that the rollover premium was very small when the devaluation occurred, and is still fairly small by October, 1999, indicating that the rollover of the public domestic debt is not, so far, a serious problem. Positive prospects for the public domestic debt market will depend, however, on the Brazilian government maintaining the current fiscal austerity program.

RESUMO Nosso objetivo é obter um modelo econométrico simples que permita construir um intervalo de confiança para a dispersão das ofertas feitas pelas instituições financeiras nos leilões semanais de títulos de curto prazo no banco central do Brasil. Sob condições competitivas (por exemplo, nenhuma coalizão entre algumas instituições financeiras), assumimos que a dispersão das ofertas está associada à volatilidade dos preços futuros da taxa de juros diária e às taxas de juros diárias que prevaleceram nos dias anteriores ao leilão. Com base nessa premissa, nosso modelo consegue separar os dois leilões com uma volatilidade extremamente alta. Em um deles, a alta dispersão pode ser prevista usando os dados de outros mercados de taxas de juros; no outro, a dispersão ficou fora do intervalo de confiança para a dispersão prevista. Isso pode ser usado como evidência empírica de uma tentativa de entrada no mercado que realmente ocorreu naquela data.

Using the different response timings of credit demand and supply, we isolate supply shifts after monetary policy shocks. We show that the bank lending channel exists in Brazil: after an increase (decrease) in the basic interest rate (Selic), banks reduce (increase) the quantity of new loans and raise (lower) interest rates. However, contrary to the empirical literature for the US, we find evidence that large banks react more than smaller ones to monetary policy shocks. Results may have important implications for monetary policy transmission in light of the recent wave of concentration in the Brazilian banking industry.