Fiscal Variables and Monetary Policy in Brazil

Abstract

This study analyzes the reaction function of the Central Bank of Brazil in setting the Selic rate, taking into account the influence of macroeconomic and fiscal variables between 2003 and 2024. To this end, we estimate different specifications of the Taylor Rule using the Generalized Method of Moments robust to heteroskedasticity and autocorrelation (GMM-HAC). We initially estimate the model with macroeconomic variables, including the lagged interest rate, the output gap, the real effective exchange rate, the deviation of inflation expectations from the target, and the commodity price index. Subsequently, we incorporate fiscal variables—namely, public debt (% of GDP) and the primary deficit (% of GDP)—to assess their impact on the conduct of monetary policy. The analysis covers the full sample and two distinct subperiods (2003–2013 and 2014–2024) for the Brazilian economy, allowing the identification of asymmetries in the monetary authority’s response over time. The results indicate strong inertia in monetary policy, as evidenced by the coefficient of the lagged interest rate. The output gap proves relevant, especially during economic and fiscal stability periods. The deviation of inflation expectations from the target influences the interest rate, reinforcing the Central Bank of Brazil’s commitment to the inflation-targeting regime. Among the fiscal variables, public debt is statistically significant, particularly when its trajectory is under control. In contrast, the primary deficit shows no short-term impact, suggesting an indirect effect through the increase in debt.