To what extent financial regulation in Brazil was effective in - - PDF document

Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model 1

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To what extent financial regulation in Brazil was effective in neutralizing the overvaluation

• f the exchange rate?

Edwin LE HERON

Sciences Po Bordeaux - Centre Émile Durkheim - ADEK - France

Project Grow th w ith financial stability and the New Developmentalism

Getulio Vargas Foundation Sao Paulo - Brazil - Thursday, March 24 2011

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Usual weaknesses of developing countries

High endebtedness Deficit in current High Inflation rate

• f the State

account Steady depreciation of the exchange rate Problems with the monetary governance Depreciated exchange rate and depreciated money Fragility of the Banking sector

Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model 2

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Second consensus of Washington

Financing  High interest rates  Overvaluation of By foreign savings (nominal and real) exchange rate    Fragility in the  Extortion of domestic Industrial exports  Banking sector profits (debt in international Currency) and in the sovereign debt (original sin) LOWER GROWTH RATE

4  Three important mistakes or three false solutions

 To finance the growth with foreign savings (from the North)  To consider the exchange rate as being determined only on a market,

with complete freedom of capital circulation

 To confuse a powerful State with an important fiscal deficit or to think

that State is the problem and not a solution

Plus a ‘specific’ Brazilian problem (Dutch disease)

If the sector of raw materials is important, there is a trend to the

• vervaluation of the exchange rate, because the raw materials sector

generates Ricardian rents. The exchange rate is not the competitive exchange rate but the rate issued from the rent seeking sector.

Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model 3

5  Four important conclusions and solutions:

 Foreign savings must be replaced by domestic monetary financing. The

national money should not be the problem, but the solution. Domestic saving will be the result of the domestic investment and of the surplus in the current account.

 Exchange rate can be controlled and the good exchange rate is the

competitive exchange rate (for the industial sector) and not the

• verevalued exchange rate issued from the market equilibrium and the

Ricardian rent sector.

 To ensure the stability of the money in the long term, it is important to

have a controlled fiscal deficit (and public debt), a balance or surplus in the current account and inflation under control. The State must be powerful, i.e. well organized, with a good governance and especially with a strong policy of redistributing income. The fiscal deficit is not important in the long term.

 Real wages should increase with productivity gains. It is important to

manage domestic demand involving the development of industrial sector

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The Brazilian case 1994-2008

Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model 4

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Real Exchange rate and Current account balance

50 100 150 200 250 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Nominal effective exchange rates Real effective exchange rate on unit labor costs in manufacturing Real effective exchange rate on consumer price levels Current account balance (Modified index) Balanced current account

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Real Exchange rate and Current account balance

50 100 150 200 250 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Nominal effective exchange rates Real effective exchange rate on unit labor costs in manufacturing Real effective exchange rate on consumer price levels Current account balance (Modified index) Balanced current account

Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model 5

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Real GDP and Current account balance in Brazil

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2 4 6 8 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Real GDP growth Current account

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Real GDP growth and real effective exchange rate

20 40 60 80 100 120 140 160 180 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Real effective exchange rate on unit labor costs in manufacturing Real GDP growth (modified Index)

Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model Dynamic Analysis of Monetary Policy Shock on Banking Behavior: A post- Keynesian Stock-Flow Consistent Model 6

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Real GDP growth and real effective exchange rate

20 40 60 80 100 120 140 160 180 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Real effective exchange rate on unit labor costs in manufacturing Real GDP growth (modified Index)

12  What are the other solutions to fight against the overvalued

exchange rate?

• Taxe on imports
• Taxe on exports of raw materials to catch a part of the rents
• Subsidy on exports of industrial goods (9% in China = profits)
• To subsidize the wages in industrial sector
• To take into account productivity gains to measure the

competitive exchange rate

• Real wages should increase with productivity gains.
• Two exchange rates (market and industrial EC as in France

after 1945 or now with Chavez)

• To control the inflows of capital assets

Inward FDI/OutwardFDI = 2,33 (2004), 2,46 (2005), 2,07 (2006), 2,41 (2007)

• A good policy mix of monetary, fiscal and income distribution

policies (non conventional monetary policy in place of IT notably)