Counter-intuitive interest rate policy
Published:Friday | June 24, 2011 | 12:00 AM
Somewhat like China, Brazil's economy is experiencing inflationary pressures reflecting tightening labour and other markets due to robust economic growth.
In both countries, the financial authorities have resorted to conventional monetary policy, that is, interest rate hikes as the main tool to combat these pressures.
In the case of Brazil, its central bank has increased interest rates five times this year, the last being earlier this month when the benchmark rate was raised by 25 basis points to 12.25 per cent, as the inflation rate moved past the official target of 6.5 per cent.
This increase kept Brazil in the position of being the country with the highest real interest rates of any large economy.
Brazil has maintained high real interest rates over several years, even as its economy has been among the fastest growing among emerging markets, which would seem counter-intuitive.
But this could be partly explained by the fact that its economic expansion has been fuelled by high commodity prices, foreign capital inflows, and spending by new consumers, all of which have been relatively less interest rate-sensitive.
That the Brazilian authorities would be preoccupied with inflation control is understandable, given the country's history of hyper-inflation.
By a balancing act that has kept exchange rate movements and inflation in a tight band, they have managed to stabilise the macro-economic environment over the past decade and a half - a possible formula for sustained stability.
As the world economy is apparently slowing, this formula will be tested, especially as China, Brazil's main trading partner that has been the major source of demand for its commodities, is determined to cut the pace of its economic growth.
Brazil's strong economic growth in an environment of high real interest rates is at odds with the debate raging in Jamaica about the role of high interest rates in the 1990s financial-sector crisis and the lacklustre performance of the local economy.
In contrast to the high rates in Brazil, real interest rates in Jamaica have turned negative since early 2010 when the Jamaica Debt Exchange programme, the JDX, was implemented. For example, while the Bank of Jamaica's (BOJ) 90-day signal rate stood at 8.0 per cent in October 2010, the point-to-point inflation rate was 11.2 per cent.
By January 2011, the BOJ's signal rate was reduced to 7.5 per cent, remaining below the point-to-point inflation rate which had come down to 10 per cent.
This situation of negative real interest rates can only be temporary if interest rates are to play the normal role of encouraging savings.
In any case, the low interest rate environment internationally that has limited the options of depositors is unusual, and rates are bound to climb in due course.
It is important to point out that by May, when the inflation rate dropped to 7 per cent, the BOJ's signal rate stood at 6.75 per cent, bringing the two rates almost in line.
The discourse in Jamaica about interest rates has been dominated by talk of a so-called low interest rate model, which is really referring to nominal rates.
But in reality, we can only talk about moderate nominal interest rates, since Jamaican inflation rates are hardly likely to go below five per cent on a sustained basis and savers must earn positive real interest rates if economic stability is to be achieved.
Dennis Morrison, Columnist