Why are real interest rates in Brazil so high?

In 2002 the ex ante real interest rate in Brazil seemed to be over fifteen percent (pdf).  The linked analysis blames the budget deficit, risky swaps premia, and other factors.  Sure enough, the Brazilian economy has done very well since 2002 and real rates are “down” to about five percent, which is still very high.  They are not so high in Chile, Mexico, or Turkey, arguably the economic peer countries of Brazil.  A different earlier analysis cites how the uncertainty of economic policy connects with international liquidity provision to generate high real rates.  Here is a paper on jurisdictional uncertainty and high rates in Brazil.  The history of high real interest rates is longer yet, covering many of the last thirty-five years.

I found the first and fourth links to offer overly complicated explanations, and those models did not offer stunningly correct predictions for the subsequent period.  The “crude” analysis is that the Brazilian savings rate is very low for a developing country (about fifteen percent of income), the size of the Brazilian government is very high for a developing country (about forty percent of gdp), and the productivity of real investment here is high because of lots of low-hanging fruit (literally and figuratively, not just tasty bananas but add on soya and off-shore drilling and other resources).  Yet bad mercantilist policies, bad labor law, and the pressure of government spending on savings all mean that the return on capital does not fall so much at the margin.  There remain many underexploited opportunities, and thus one can be a Brazil optimist while seeing only a tolerably good policy environment, but tolerably good it seems to be.

Sometimes, when risk and liquidity factors intervene, the real rate of interest is especially high, but it is quite high to begin with.

Sometimes it is argued that when the “U.S. monetary expansion ends” (please don’t debate that issue in the comments on this post), Brazilian real interest rates will rise once again to extreme levels.

High real interest rates keep Brazil relatively free of excess private sector debt.

It is odd how little economists understand about real interest rates.


you r rgiht about the Turkey. Our rates are going up.

"the productivity of real investment here is high" - doesn't that determine the real real interest rate? Can borrowing be used as an alternative to foreign currency exchange?

"It is odd how little economists understand about real interest rates."

prices, always aggregating information about more facts than can be centralized in any single mind.

You mean economists that have never done serious research on interest rates for a long time and in several countries, and to make things worse they hardly understand how the great variety of financial systems around the world work. FYI, the same happens with economists that have never done serious research on energy prices, agricultural prices, wages, and in general on the prices of a large number of products that we put together in a category (finance, energy, agriculture, labor). Not surprisingly most of these economists are macroeconomists --the sort of economist that relies on national accounting and cherry-picks evidence from the microeconomic analysis of those categories.

Alex Schwartsman (from Mão Visivel http://maovisivel.blogspot.com , the best macroeconomics blog in Brazil) offers a different explanation for the high interest rates in Brazil. He says that interest rates are high due to TJLP ("long-term interest rates"). This is the reference interest rate charged by BNDES, which is responsible for a considerable part of the credit for productive activities in Brazil. The current TJLP is 6%. Without TJLP, the equilibrium interest rate would be much lower.

I agree that we don't understand this very well. But I thought there was a common observation, that countries with high inflation have high real interest rates for a time after they disinflate. Brazil's the case I use in class, but you could also look at Turkey, the US in the 1980s, etc. It's hard to model this precisely, but the approach I've seen is that people doubt inflation will stay low.

Remember that nominal government bond yields have three components--real rates, expected inflation, and a risk premium for bearing inflation risk. A lot of people forget this last component. Maybe real rates are normal, but there is a high inflation risk premium. If Brazil has had periodic bouts of double digit inflation, bondholders will want to be compensated for this risk.

Also, interest rates are forward looking, but actual inflation is a backwards (historical) measure. You can have an unexpected burst of inflation (say, through an oil shock), but if the market believes that it is transitory, interest rates won't move or even go down (see 2008).

I'm amazed at the number of very smart economists and financial analysts that confuse all this. Too many people think that the US had high real interest rates in the 1980s, but I believe that the market was pricing in a 1% or 2% inflation risk premium in nominal yields. There were people predicting 25% inflation in the early 1980s. It wasn't until the late-1990s that the market finally believed that the Fed could and would contain inflation risks.

The majority of economists (IMHO) understand nothing about how economies work. Hence the large number of Keynesian economists. I am sympathetic to the difficulty of understanding extremely complex, non-linear systems but I wish that people who understand very little about their subject would refrain from making such definitive statements implying they do understand their subject.
There are good reasons for Brazil's higher than expected interest rates. However, understanding and elucidating these reasons is very difficult and the economics community has demonstrated time and again that the reasoning proceeds from what they wish to be true (their political views) and then to finding reasons that fit these political views rather than seeking understanding of how real economies behave. That has been the curse of economics from its founding (probably why it was called "political economy" early on). First, the economists picks his/her politics and tries to warp economic behavior to fit that bias rather than trying to understand economic behavior and draw conclusions and make verifiable predictions based on those conclusions, and then modifying these principles based on the accuracy of the predictions, (repeat ad infinitum) as real scientists do. Economics theory is simply political theory (ie, moralization) with a veneer of pseudo-science overlaid. Don't expect that economists understand, or can explain, anything that happens in the real world.

Please tell me which three books on economics have you read and/or which three economists you talked to in the past 5 years and why you didn't like them.

Economists whose work I LIKE include:
F. Hayek--many books--for example, Road to Serfdom
J.H. De Soto--Money, Bank Credit and Economics Cycles
M. Pettis--China Financial Markets blog

DON'T LIKES include:
P Krugman: his columns distort facts and make very sensible claims such as only by spending enormous sums you don't have can you get out of debt. Obvious idiocy to all but famous economists. Japan is a real world example of how well that works.
A. Greenspan: Responded to collapse of a stock bubble by creating a housing bubble. The effects of low interest rates on malinvestment have been pointed out (and proved in many economies) but were ignored by virtually all economists.
B. Bernake: Responded to collapse of mal-investment by private sector (at behest of public sector) by converted private bad debts into public bad debts that cannot be repaid, converting insovency of private banks into insolvency of a nation. Monetizing government debt despite centuries of experience about the ultimate outcome of that process. Most economists once ignore the obvious results of these well known errors for political reasons.

I cannot appeal to authority as virtually the entire economics profession is is behind the idiots. I simply state, as an observation, that economics is not a science but simply pseudo-scientific babble used to justify political actions that suit the economists and their political masters.

Thanks for your reply. I know well most of Hayek's work and some of de Soto's work. I have met with Jesús Huerta de Soto a few times in the past 10 years (I live in Santiago Chile but I visit Spain often). Leaving aside the broader issues of Austrian economics vs. Neoclassical economics, I have always disagreed with de Soto about his views on the monetary system (on the other hand, in the 1970s I was in favor of Hayek's currency competition). Indeed Hayek and de Soto are quite different from PK, Greenspan and Bernanke, but all of them illustrate the limits of economics. Scholars (all of them but Greenspan) have yet to explain the macroeconomy (I mean long-term growth and fluctuations) on the basis of neoclassical microeconomics and of the insights of Austrian economics. Frustration with macroeconomics --particularly with Keynesian macroeconomics-- was already apparent in the late 1960s, and there has been little success in providing a good alternative (in my view the survival of Keynesian macroeconomics is evidence of this limited success).
You say that you like Michael Pettis' analysis of China financial markets. I understand why you may like it --he provides a lot of details about what is going on in China, something that almost no other economist does. And clearly Pettis knows the economics of financial markets and Keynesian macroeconomics. I don't like his analysis however. I spent three years in Beijing (1994-96) as an adviser to agencies working on the reform of state banks and enterprises and I can only laugh when I read that
"Whether or not we have reached the point in China in which investment is misallocated and debt levels rising is clearly a matter for heated debate – I think we have already passed that point – but clearly we are tending in that direction. The key problem, I think, is the way in which the financial system allocates capital. Every financial system is capable of periods of capital misallocation, and this almost always seems to happen during periods of very low interest rates and rapid money expansion, but some financial systems do this more extravagantly than others."
Pettis wrote that paragraph a few days ago. I used to write similar paragraphs in 1994 and lengthy reports on the reasons for such ideas by 1996. Whenever I read Pettis' analysis, I have the impression that he knows a lot of details but that he still lacks a view of how the Chinese economy and in particular its financial system works. It's a tough job and most foreigners have an urgency to come out with analyses that make sense so they rely too much on how they understand the American economy and in particular its financial system. My background is different --although I have a Ph.D. from U. of Minn., most of my long academic and professional career has been in developing countries, particularly countries in which fiscal and financial crises have been common.
Keep reading Hayek (I'm not sure about de Soto) but unfortunately I cannot suggest you any shortcut to a greater understanding of economics and the world economy. I started over 50 years ago and I'm still struggling to make sense of what many economists say.

@GaryP: "There are good reasons for Brazil’s higher than expected interest rates."

Could you expand? Or is this merely a claim that there _must_ be good reasons for them?

I make no claim to understanding the "reason" behind seemingly unreasonable actions of a large, complex system such as a national economy. I do assert that even seemingly irrational markets are acting that way for reasons that can be understood and (at least) appear rational from the point of view of the many people whose choices create a market. The behavior of markets (especially markets distorted by government actions) can appear incomprehensible but I posit that, if all causes are considered, they will understandable, even if they are ultimately dysfunctional.
One short example:
Based on the near certainty that the US govt debt will not be repaid (in today's equivalent dollars) why are US Treasury rates so low?
Possible reasons: The FED is monetizing the debt and is in effect giving bond dealers easy profits (dealers buy bonds, FED buys from dealers) to maintain the fiction that there is a demand for US bonds. Also, the carry trade creates demand for US bonds (enabled by negative short term rates is likely a unofficial quid pro quo required of large banks by FED to maintain these negative rates). These reasons are not obvious (indeed they somewhat hidden and actively ignored by politically motivated economists) but they are possible explanations for seemly incomprehensible rates. However, few economists would ever consider looking for real reasons for this situation because it might expose the Ponzi.
Examples of incomprehensible economic facts abound. Why did banks lend money to people they had to know would not repay it? Why are equity markets so highly valued in such uncertain times? Why are Japanese long term rates so low? Why is consumption such a small part of the Chinese economy? All these oddities have real, understandable reasons. However, they cannot be understood with complex equations, only with an eye to how political decisions incentivize seemingly irrational behavior.
Can I explain interest rates in Brazil? No. But they can be explained if you are willing to study the market, discard preconceptions and seek out the real causes, regardless of whom these causes embarrass. Economists don't do this because papers get published (and Nobel's awarded) based on neat theories, not messy political facts.

Talk about not understanding real interest rates.

In reality, ex-post "real" interest rates depend on how inflation differed from its expectations. This, I concede, not many economists (including yourself) realize.

A lender will add a relatively large premium to his interest rate if there is a chance of hyperinflation. And with Brazil's history, not many expected inflation to remain so low for so long. Ex-post, if these fears do not materialize, ex-post real interest rates will seem too high. This is what happened for Brazil. The period of fall in ex-post real interest rates is connected with the growing credibility of the central bank and the fall of said premium.

When people have a hammer, they see low-hanging fruit everywhere.

Tyler couldn´t you argue that neoclassical economists poorly understand real interest rates?
In the tradition of a monetary theory of production (keynes, marx, kalecki), where interest rates are wholely a monetary phenomenon they are very well understood

Heh. "Real interest rates".

You have no clue of how high is "high interest rates" in Brazil.
I have an account in the US. My overdraft loan interest rate for this account is 9.90% yearly.
I have an account in Brazil. My overdraft loan interest rate for this account is 159.48% yearly.
I'm not joking, believe me.
Explanation? Really simple. Try the combination of a highly regulated financial system where the only regulatory goal is to protect highly inefficient federal state banks; irresponsible federal debt management that validates whatever rate markets asks for; abnormally low, subsidized interest rates for large and government-connected traditional groups and sectors, provided by the federal investment bank; macroeconomic uncertainty; an inefficient and poorly designed legal and justice system; and a huge wedge between lenders and borrowers rates, created by an incredibly complicated network of taxes on financial intermediation, which, after all, needs to be taxed because "finance is evil" (as long as it's not subsidized finance for government cronies).

capital does not fall so much at the margin. There remain many underexploited opportunities, and thus one can be a Brazil optimist while seeing only a tolerably good policy environment, but tolerably good it seems to be.

Sometimes, when risk and liquidity factors intervene, the real rate of interest is especially high, but it is quite high to begin with.

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