A modified Taylor rule for the Brazilian economy: convention and conservatism in eleven years of inflation targeting (2000-2010)

André de Melo Modenesi, Norberto Montani Martins and Rui Modenesi

Journal of Post Keynesian Economics, 2013, vol. 35, issue 3, 463-482

Abstract: With the purpose of evaluating Brazilian Central Bank's (BCB) conduct of monetary policy after the adoption of inflation targeting (IT), we estimate a modified version of the Taylor rule for the Brazilian economy in the period 2000-2010. The term modified refers to an important innovation with regard to the reviewed literature: the inclusion of a proxy for the international interest rate in the original equation. This study reinforces and expands results achieved by Modenesi (2011) and also provides a new evidence that the BCB reacts to foreign interest rates when setting its basic rate (Selic). The BCB has reduced autonomy: Selic is endogenous not only to domestic conditions (inflation and output gaps) but also to foreign interest rates (measured by the LIBOR). The evidence provided might support the argument that BCB policy is ruled by a proconservative convention substantiated in the adoption of a Taylor rule containing three distinctive features: (1) a high degree of interest rate smoothness; (2) a high pure domestic equilibrium interest rate; and (3) high interest rate differential. Items (2) and (3) largely explain the overvaluation of the real, a key element of price stabilization.

Date: 2013
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DOI: 10.2753/PKE0160-3477350308

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