Loyo suggests that the construction of a

Loyo (2006) suggests that the construction of a yield curve in the Brazilian financial system could become viable if the National Treasury issued long-term floating rate bonds, with higher returns, and in the meantime the Central Bank decreased the Selic rate, bringing more volatility to this rate. This procedure, says Loyo (2006), might help construct a term structure of the interest rate more compatible with those found in countries with well-developed financial systems. In these conditions, how could monetary policy help public debt management in order to create a positive yield curve in Brazil? Loyo (2006) argues that Franco\'s (2005) assumption, regarding an increase in the volatility of the Brazilian benchmark Selic interest rate, could raise some doubts once the decrease in demand for higher volatility securities might not mean an increase in other financial assets. In this sense, Loyo (2006) says that a successful lengthening of public debt would involve a great deal of uncertainty pmsf regarding monetary policy action. Therefore, the Brazilian Central Bank would have to target inflation as well as interest rate stability and, as soon as investors incorporated these variables to their risk assessment, the lengthening of debt maturity would become feasible. Notwithstanding, Loyo (2006) suggests that monetary policy should keep its benchmark interest rate constant around its neutral rate, and maintain small but persistent deviations, rather than large shocks. This would motivate agents to agree to lengthen their investments and improving the debt profile. Mendonça and Silva (2008) analyze the relationship between monetary policy focused on a disinflationary process and fiscal equilibrium. The authors argue that when interest rates are high and public debt consists mainly of interest rate-linked bonds, the conduct of fiscal policy would be compromised, due to expensive financial costs to the public budget. Therefore, an effective public debt management would be a good strategy to lessen fiscal policy costs and an adequate tool to avoid deterioration in the Debt/GDP ratio.
Public debt management in Brazil after 1995 The period ranging from July/1994 to January/1999 marks a monetary regime based on the exchange rate as an anchor, i.e., a source of nominal rigidity to other prices. At that time, Brazilian economic authorities used to attract foreign capital flows by managing the country\'s public debt as an instrument for hedging against the exchange rate risk. In addition to that, the Central Bank raised its benchmark Selic rate to attract even more external savings. As a consequence, the share of Selic-indexed securities increased from 20.46% of the public debt, in 1997, to 61.51% in 1999. At the same time, the share of exchange rate linked securities went from 11.64% to 26.06%, as depicted in Fig. 1. In 1998, the Brazilian government adopted a target for the primary surplus to guide its fiscal policy and, in 1999, an inflation targeting system was implemented in substitution to the exchange rate anchor, restoring macroeconomic stability. According to Pedras (2009), the new fiscal policy orientation, aimed at reducing Debt/GDP ratio in the medium term, made feasible the issuance of inflation-linked securities, in order to meet potential demand from pension funds, and also to allow for the lengthening of the Brazilian public debt. In 2002, however, uncertainties concerning presidential elections made investors become more skeptical about the Brazilian economy, as they believed fiscal dominance would become a problem if the Labor Party won the elections (Favero and Giavazzi, 2005). Nonetheless, as the new government sworn in, it pursued credible policies, with more restrictive fiscal and monetary policies. With these actions, the government was able to recover its credibility, reducing sovereign risk and inflation, stabilizing the exchange rate, and controlling public debt dynamics (Bresser-Pereira and Gomes da Silva, 2008).