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06-11-22 IS BRAZIL DIFFERENT? RISK, DOLLARIZATION, AND INTEREST IN EMERGING MARKETS1 XXXV Encontro Nacional de Economia – ANPEC 2007 Área 3 - Macroeconomia, Economia Monetária e Finanças Edmar L. Bacha Casa das Garças Institute for Economic Policy Studies Avenida Padre Leonel Franca 135 Rio de Janeiro, RJ, Brazil 22451-000 [email protected] Márcio Holland2 Vargas Foundation São Paulo School of Economics Rua Itapeva 474, 12th floor São Paulo, SP, Brazil 01332-000 [email protected] Fernando M. Gonçalves International Monetary Fund 700 19th Street Washington, DC 20431 [email protected] Abstract: With a panel-data approach, this paper expands the scope of the financial dollarization literature to investigate the determinants of the real interest rate in emerging economies. We found that real interest rates depend on the risks of debt dilution and default, expressed by inflation volatility and acceleration, as well as public debt size, investment-grade status, and per capita income. As anticipated in an analytical model, the availability of dollar-denominated deposits reduces the local-currency real interest rate. The estimated model is used to analyze the mystery of Brazil’s high real interest rates. Our empirical model is unable to explain the sky-high level of real interest rates in the aftermath of Brazil’s 1994 exchange-rate-based inflation stabilization. However, with the help of a proposed Central Bank prudence rule in face of adverse expectations, we argue that, since the adoption in 1999 of inflation targeting and floating exchange rates, Brazil’s real interest rates are slowly converging to our model’s predicted values. JEL Classification: E43, F31, O16, O23, O54 Key words: financial dollarization, interest rates, emerging economies, panel data, Brazil Resumo: A partir de uma abordagem em painel, este artigo expande o escopo da literatura sobre dolarização financeira para investigar os determinantes da

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