MONETARY POLICY AND EXTERNAL VULNERABILITY IN BRAZIL

Abstract

This paper analyses monetary policy in Brazil, investigating why interest rates were so high and volatile from 1995 to 1998. We identify in monetary policy an overreaction to external shocks, where exogenous changes in international liquidity triggered sharp movements on domestic interest rates. We also show that the Brazilian policy response to these shocks was far more intense than in Argentina and Mexico. We argue that Brazil was caught in a high interest rates trap, which culminated in a currency crisis in January 1999.