Sailing through the Global Financial Storm: Brazil’s Recent Experience with Monetary and Macro Prudential Policies to Lean Against the Financial Cycle and Deal with Systemic Risks

Abstract

Brazil sailed well through the global financial storm, using counter-cyclical policies to engineer its fast V-shaped recovery in 2010. In order to deal with inflationary pressures arising from its strong recovery, after the peak of the crisis, it used standard aggregate demand management instruments (tight fiscal and monetary policies). Brazil had also to deal with the post-QE global environment of excess liquidity in 2010-2011 where excessive capital inflows were exacerbating domestic credit growth with potentially destabilizing effects for price and financial stability. In that front, Brazil maintained and strengthened its strong financial sector regulation and supervision to continue to ensure financial stability, in particular, using a set of macroprudential instruments. While combining monetary and macroprudential instruments to lean against the financial cycle, the Central Bank of Brazil has always made clear that macroprudential measures are not a substitute for monetary policy action and are primarily geared at addressing financial stability risks. In fact, many policy makers after the global financial crisis seem to see now a complementarity between macroprudential measures and monetary policy. Accordingly, the (new) separation principle seems to evolve into using two instruments (the central bank’s base rate and a set of macroprudential tools) to address two objectives (the inflation target and a composite set of financial stability indicators). Brazil’s recent experience with monetary and macroprudential policies is a successful example of this new approach. More time and other countries’ experiences are needed to assess properly if this policy option can be generalized and replicated with similar results elsewhere.