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A political economy essay on the fiscal and monetary interactions in Brazil

Abstract : One of the principal conclusions of modern macroeconomics is that fiscal dominance is a threat to price stability. This ‘unpleasant dominance’ describes a particular situation in which short-sighted politicians would use the central bank’s power to create money so to accommodate the financial needs of the government. The empirical demonstration of fiscal dominance firstly presented by Sargent and Wallace (1981) unveiled a positive correlation between price instability and this specific dysfunction in fiscal and monetary interactions. The emphasis placed by the subsequent contributions on the benefits of having a monetary-dominant regime to mitigate the risk of fiscal dominance, our documentary analysis suggests, faded away more consistent discussions about non-dominant solutions. This thesis seeks to fill this gap by investigating how the idea of monetary dominance has been generating negative externalities over the fiscal balance of the government. We argue that this notion is none but a partial solution. This is because the influence of interest groups over monetary decisions are often neglected, as central banks are assumed to be impartial institutions interacting with irrational governments which choices are likely to generate time-inconsistency problems. Two fundamental limitations of these assumptions are then acknowledged. Firstly, by rarely looking at the social and institutional mechanisms through which price instability can arise, a minimal emphasis is given to what we will call here as the ‘financialisation of monetary policy’ – a distortion in monetary choices leading to the maximisation of private gains at the expenses of collective losses. Secondly, little attention is paid to the negative externalities of monetary dominance over the fiscal balance of the government. These limitations are explored through a political economy analysis of the repurchase agreements (repo) used for monetary purposes in Brazil during the period 2006-2016. At the same time that these operations were extensively deployed by the Brazilian central bank to make inflation converge to the target, we show that repo count among the most important sources of funding for the major commercial banks in the country. The ‘double character’ of this financial instrument suggests that central bank decisions are not purely ‘technical’ but also political, which consequently calls for a study that integrates the conflict of interests over monetary decisions, as well as the mechanisms at the disposal of the central bank to deal with the action of organised interest groups. We, therefore, go beyond the assumption of inflation as a merely ‘monetary disease’, to investigate the economic forces that lie behind the excessive injections of money into the Brazilian interbank market. This is how this thesis intends to contribute to rethinking monetary policy theory and the nature of public borrowing.
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Marcos Centurión-Vicéncio. A political economy essay on the fiscal and monetary interactions in Brazil. Economics and Finance. Université Grenoble Alpes [2020-..], 2020. English. ⟨NNT : 2020GRALE004⟩. ⟨tel-03263555⟩

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