Stanford economist John Cochrane says André Lara Resende’s proposal for sharply lowering Brazil’s benchmark interest rate has no historical precedent. Cochrane called the plan sophisticated and intriguing, while cautioning that it ventures into theoretical territory that has never been tested.
Resende, one of the architects of Brazil’s Real Plan, argues that high interest payments—not primary public spending—are driving the country’s fiscal difficulties. His proposal would have a National Fiscal and Monetary Council set a target range for the Selic rate, currently at 13.75%, between the 3% inflation target and potential nominal GDP growth of 5.5%.
Under the plan, the central bank would gradually cut the rate to about 7.5% over 12 months. Brazil would also use its international reserves to limit pressure on the real. Resende argues that very high interest rates can themselves contribute to inflation, and that lowering the benchmark rate would not necessarily create additional inflationary pressure.
Cochrane responded to the proposal on Tuesday on his blog, The Grumpy Economist. He noted that there are precedents for reform packages that bring inflation down, reduce debt and lower interest rates, but said those outcomes have occurred together. That does not prove Resende is wrong, Cochrane wrote; it means the proposal has not been tested in isolation.
A central part of Resende’s argument draws on Cochrane’s fiscal theory of the price level, which holds that fiscal policy, rather than monetary policy alone, determines inflation. Resende also proposes setting fiscal and monetary goals for five years and using international reserves to defend the currency after interest-rate cuts.
Cochrane is skeptical that the fiscal measures would be sufficient. He welcomed the idea of simplifying revenue and spending, but questioned whether multi-year targets would hold in practice. For the mechanism to work, he said, markets would need to believe the government would run future surpluses—a commitment that depends more on durable institutions than on targets alone.
He also questioned whether the government would leave untouched an amount equivalent to roughly 8% of GDP, asking whether Brazil would really avoid spending more or collecting less in taxes. As a possible institutional example, he pointed to Switzerland’s constitutional debt brake, while noting that Swiss households are unusually inclined to save.
Cochrane also doubts the plan to use reserves to restrain depreciation of the real, citing Latin America’s long record of largely unsuccessful currency defenses. If lower interest rates improve Brazil’s prospects, he argued, the currency should strengthen rather than weaken.
Instead of endorsing or rejecting Resende’s plan, Cochrane said he prefers coordinated fiscal, monetary and microeconomic reforms, drawing a comparison with the reform packages of the 1990s. He regards growth-oriented reforms as especially important. While raising doubts about key elements, he praised Resende’s argument as coherent and more nuanced than a simple case for lower interest rates.
Sources: Folha Mercado.