FGV traces Brazil's high neutral rate to public spending, not abroad

Summary

In an 18-page study in the September macro bulletin of Rio de Janeiro-based FGV IBRE, announced on its blog on 1 October 2026, Silvia Matos, Caio Dianin and Samuel Pessôa recalculate Brazil's neutral interest rate. The neutral rate is the real interest rate that keeps inflation stable while the economy grows at its potential pace. Using 2 different methods, the authors arrive at estimates ranging from 6.7% to 8.1% between 2024 and August 2026, with an average of 7.5%. That is about 2.7 times the 2018–2019 average of 2.8% and the highest of the periods examined.

The authors recall that the policy rate rose to 10.5% in September 2024 and to 15% in June 2025. The 1-year real interest rate was 5.9% in February 2024 and has at times exceeded 9.5% in recent months. Even after deducting country risk as measured by 5-year CDS, the interest rate gap between Brazil and the US has risen above its level during the 2014–2016 recession. By contrast, the neutral rate the New York Fed calculates for the US sits in a 1.0–1.5% band, the same place as in 2018–2019.

The paper's central thesis follows from this comparison: if nothing abroad is pushing rates up, the causes must be sought at home. In a model based on Pessôa's earlier work, the risk of a sudden collapse in emerging economies, which CDS does not capture, prevents capital flows from closing the interest rate gap. Beyond a certain point the economy behaves like a closed economy. Real interest rates are then set by domestic demand, and public spending becomes decisive. The authors show that federal spending rose from 15% to 19.5% of GDP between 2003 and 2016. During the spending cap period, by contrast, rates fell to historic lows for 3 years.