Interest Rates in the United States and the Consequences in Brazil

BRAZIL ECONOMICS - Report 10 Oct 2023 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

Against a backdrop of a still heated economy and tight labor market, the indication that the interest rate will remain “higher for longer” in the US does not exclude the possibility of further elevation.

The resilience of the American economy to the Fed’s tighter monetary policy is a consequence of the government’s fiscal policy, which has been expansionary since 2020. The effects of the fiscal expansion have not been limited to the multiplier effect of public spending. Since the debt is a component of wealth, its expansion after the pandemic has generated a wealth effect for the holders of American bonds.

The expansionary fiscal policy is affecting the Fed’s monetary policy through the increase of the neutral interest rate, defined as the risk-free rate at which aggregate demand growth is equal to potential GDP growth. The limited response of economic activity to the high interest rates is an indication that the neutral rate is rising.The market’s perception of a higher neutral interest rate, and that monetary policy will be in restrictive territory for longer than previously thought, has led to an increase along the yield curve, reinforcing the tightening of financial conditions.

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