Inflation Targeting and Debt: Lessons from Brazil

23 Pages Posted: 6 Apr 2004 Last revised: 23 Nov 2022

See all articles by Carlo A. Favero

Carlo A. Favero

Bocconi University - Department of Economics; Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Francesco Giavazzi

National Bureau of Economic Research (NBER); University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2004

Abstract

Studying the recent experience of Brazil the paper explains how default risk is at the centre of the mechanism through which an emerging market central bank that targets inflation might lose control of inflation--in other words of the mechanism through which the economy might move from a regime of 'monetary dominance' to one of 'fiscal dominance'. The literature, from Sargent and Wallace (1981) to the modern fiscal theory of the price level has discussed how an unsustainable fiscal policy may hinder the effectiveness of monetary policy, to the point that an increase in interest rates can have a perverse effect on inflation. We show that the presence of default risk reinforces the possibility that a vicious circle might arise, making the fiscal constraint on monetary policy more stringent.

Suggested Citation

Favero, Carlo A. and Giavazzi, Francesco and Giavazzi, Francesco, Inflation Targeting and Debt: Lessons from Brazil (March 2004). NBER Working Paper No. w10390, Available at SSRN: https://ssrn.com/abstract=522270

Carlo A. Favero

Bocconi University - Department of Economics ( email )

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Bocconi University - Department of Finance ( email )

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Italy

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Centre for Economic Policy Research (CEPR)

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Francesco Giavazzi (Contact Author)

University of Bocconi - Innocenzo Gasparini Institute for Economic Research (IGIER) ( email )

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Centre for Economic Policy Research (CEPR)

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