International Macroeconomic Impacts on the Brazilian Economy: a note

Fernando de Holanda Barbosa Filho

IBRE – FGV Brazilian Institute of Economics – Getulio Vargas

Foundation

Outline

• Immediate post subprime crisis analysis of Brazil – Terms of Trade – GDP Composition

• Quantitative Easing and Tapering – QE – Tapering – Brazil´s vulnerability

• Growth Decomposition and Fiscal Policy Shift – Growth Decomposition – Fiscal Policy

Immediate After Crisis

• Brazil was growing above 4% in 2008. • The crisis hit the Brazilian economy very hard

(-2.7% in the last quarter 2008). • Sharp recover in 2010: a “V” shape recovery. • Expansionary Fiscal and Monetary Policies.

GDP Recovery

Terms of Trade

• The world deceleration caused an increase in Brazilian Terms of Trade.

GDP Composition

• The terms of trade increase change domestic relative prices between tradable and non tradable goods.

• These relative price changes modified Brazilian GDP composition.

• This benefited the service sector and damaged the industry growth.

GDP Composition

GDP Composition

Unit Labor Cost • ULC increase considerably in Brazil over the last decade. This

causes the industry to lose its competitiveness. • Therefore, after the crisis the drop in demand for

manufactured goods affected negatively the Brazilian industry: a “marginal” industry in the world.

Table 1: Unit Labor Cost Decomposition 2002-2006 2003-2007 2004-2008 2005-2009 2006-2010 ULC 10.6 11.6 13.1 6.5 8.4 Wages 11.6 13.9 15.4 8.1 11.6 Labor Productivity 1.1 2.3 2.2 2.0 3.2 2002-2006 2002-2007 2002-2008 2002-2009 2002-2010 ULC 10.6 10.0 9.9 8.8 9.5 Wages 11.6 11.8 11.8 10.4 11.6 Labor Productivity 1.1 1.8 1.9 1.5 2.1 Source: Mello and Barbosa Filho (2013)

Quantitative Easing

• The zero lower bound interest rates was reached in 2008.

• Therefore, monetary policy designed to strengthen economic activity adopted a Quantitative Easing in 2008.

Table 2: Monetary Policy Announcements

Announcement Beginning End QE1 November 2008 December 2008 March 2010 QE2 august 2010 November 2010 June 2011 QE3 September 2012 September 2012 - Tapering May 2013 First quarter 2014

Quantitative Easing

• There is no agreement on the positive effects of such policy.

• Woodford (2012) analyses the QE policy in two different groups: changes in central bank policy sheets and forward guidance. He concludes that QE policy affects the markets through forward guidance, as signaling mechanism that strengthens forward guidance (Krishnamurthy and Cissing-Jorgensen(2011))

QE – Effects in Brazil

• QE signaled a long period of low interest rates. • This lowers Brazilian interest rates and appreciates its

currency (“Currency war”). • The terms of trade shock by itself would appreciate

the BRL. The QE might have amplified this effect.

QE – Effects in Brazil

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Figure 6: Nominal Exchange Rate (R$/US$)

Source: BACEN.

QE – Effects in Brazil

• The long period of low interest rates allowed Brazilian Central Bank (BACEN) to reduce interest rates.

• However, BACEN dropped interest rates too much and inflation accelerated.

QE – Effects in Brazil

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Figure 7: Real Interest Rates (Swap 360)

Average 2001 /

Average 2004 / 2005

Average 2006 / 2008

Average 2009 / 2014

Source: BACEN.

Tapering

• As the QE, the Tapering also affects the economy through a signaling mechanism.

• The Tapering announcement anticipated interest rates increases by more than a year.

• Interest rates were expected to increase only in 2016.

• The announcement anticipated this process that was later postponed.

Tapering

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Figure 8: Tapering Effects on Future Interest Rates

04/30/2013

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Tapering

• The Tapering announcement fueled a fast interest rates increase and BRL depreciation.

Interest Rates Increase

BRL Depreciation

• The BRL depreciation was over 20% in a period inferior to 4 months.

• The real exchange rate is expected to increase in the next months: we have a combination of increase in Net external liabilities, drop in terms of trade and decrease in relative productivity. All of them cause exchange rate depreciation.

BRL Depreciation

BRL Depreciation

• However the short term impact was too sharp. • It raised questions about Brazil´s vulnerability. • We run some models to evaluate the reason for this

fast adjustment in the BRL. • The select model combined debt service with

primary exports to China:

tt PECDSe εααα +++=∆ 20122201210

BRL Depreciation

• The results showed that the countries that had higher exchange rate depreciation were the ones with higher debt service and exposure to primary exports to China.

Table 4: Results of the regression model 1 model 2 model 3 2012 Public Debt 0.09*

Basic Interest rates 1.26* Service Debt 3.45* 3.99*

Primary Exports to China 1,29* R2 0.74 0.67 0.86 * significant at 5%.

BRL Depreciation

Growth Decomposition

• We decomposed GDP growth using a Cobb-Douglas production function:

• A growth decomposition analysis shows that GDP growth drop was caused mainly by a productivity drop.

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Table 5: Growth Decomposition Analysis GDP TFP Labor Capital

2002-2010 3,9 1,6 1,0 1,4 39,6 25,6 34,8

2010-2013 1,9 0,0 0,3 1,6 0,6 16,3 83,1

∆ between Periods -2,0 -1,6 -0,7 0,2 77,6 34,6 -12,2

Source: Barbosa Filho and Pessôa (2014).

Growth Decomposition

• We also decomposed the TFP in labor productivity and capital productivity: CP

CPLPLP

AA

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+−= αα )1(

Table 6: TFP Decomposition

TFP Labor Productivity Capital Productivity

2002-2010 1,6 1,2 0,4 74 26

2010-2013 0,0 0,8 -0,7 6721 -6621

∆ between Periods -1,6 -0,4 -1,1 26,3 73,7 Source: Barbosa Filho and Pessôa (2014).

Fiscal Policy

• After the subprime crisis Brazil loosened its fiscal policy. • The countercyclical fiscal policy during the crisis was

justifiable. • However, even after the crisis the country adopted a primary

surplus consistently below the levels prior to the crisis. • It also announced primary surplus goals that were achieved

only by using “creative accounting” . • As a result we observed an increase in gross debt. • And worse than that, credibility loss.

Fiscal Policy

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Figure 13: Primary Surplus and Gross Debt

Official (left) Actual (left) Gross Debt (right)

Conclusion

• Brazil is a small open economy and as such is affected by US interest rates expectations that impact also exchange rates.

• The main impacts of international crisis came through real variables: lower world growth, terms of trade changes and shifts in Brazilian fiscal policy.

• The QE and Tapering policies affected manly nominal variables by the forward guidance mechanism.

• The huge effects of the Tapering announcement on the BRL were due to a loosening of fiscal policy that also deteriorates the long-run real exchange rate.