The Brazilian experience in managing interest-exchange rate nexus

Abstract

The interest-exchange rate nexus has been the paramount determinant of the course of the exchange rate in contemporary Brazil through the operation of carry trade which has different forms, all related to the interest rate differential. To explain how this works in Brazil and how the Government has been dealing with it through the exchange rate policy this paper addresses four main questions: firstly, it discusses some theoretical background related to the interest-exchange rate nexus; secondly, it makes an attempt to explain why the interest rate in Brazil is so high, examining briefly the main explanations for it; thirdly it describes the Brazil’s foreign exchange markets, their size and hierarchy; lastly it explains the carry trade dynamics in different foreign exchange markets and also the government policies envisioned to curb it. In the final remarks, some recommendations to improve the foreign exchange market regulation are made.