Fiscal Dominance in the Brazilian Economy? Econometric Analysis by the Method of Simulated Moments

Abstract

This work investigates the possibility of fiscal dominance in Brazil and analyses the effectiveness of controlling inflation by increasing the basic interest rate. Our analysis considers an empirical model estimated by the Method of Simulated Moments (MSM), which allows us to make stochastic projections for the relevant economic variables and identify their impacts on the debt’s solvency. Estimating macro equations using the method of moments avoids the problem of possible correlation between residuals and explanatory variables. We consider different fiscal scenarios and obtain conditional probabilities of fiscal dominance. Our main conclusion is that –no matter the scenario and in spite of a greater fiscal deterioration– the probability of the Brazilian economy finding itself in a state of fiscal dominance in the post-pandemic years is negligible.