BRAZIL does not look like an economy on the verge of overheating. The IMF expects it to shrink by 3% this year, and 1% next. (The country has not suffered two straight years of contraction since 1930-31.) Fully 1.2m jobs vanished in the year to September; unemployment has reached 7.6%, up from 4.9% a year ago. Those still in work are finding it harder to make ends meet: real (ie, adjusted for inflation) wages are down 4.3% year-on-year. Despite the weak economy, inflation is nudging double digits. The central bank recently conceded that it will miss its 4.5% inflation target next year. Markets don’t expect it to be met before 2019.

If fast-rising prices are simply a passing effect of the real’s recent fall, which has pushed up the cost of imported goods, then they are not too troubling. But some economists have a more alarming explanation: that Brazil’s budgetary woes are so extreme that they have undermined the central bank’s power to fight inflation—a phenomenon known as fiscal dominance.

The immediate causes of Brazil’s troubles are external: the weak world economy, and China’s faltering appetite for oil and iron ore in particular, have enfeebled both exports and investment. But much of the country’s pain is self-inflicted. The president, Dilma Rousseff, could have used the commodity windfall from her first term in 2011-14 to trim the bloated state, which swallows 36% of GDP in taxes despite offering few decent public services in return. Instead, she splurged on handouts, subsidised loans and costly tax breaks for favoured industries. These fuelled a consumption boom, and with it inflation, while hiding the economy’s underlying weaknesses: thick red tape, impenetrable taxes, an unskilled workforce and shoddy infrastructure.

The government’s profligacy also left the public finances in tatters. The primary balance (before interest payments) went from a surplus of 3.1% of GDP in 2011 to a forecast deficit of 0.9% this year. In the same period public debt has swollen to 65% of GDP, an increase of 13 percentage points. That is lower than in many rich countries, but Brazil pays much higher interest on its debt, the vast majority of which is denominated in reais and of relatively short maturity. It will spend 8.5% of GDP this year servicing it, more than any other big country. In September it lost its investment-grade credit rating.

Stagflation of the sort Brazil is experiencing presents central bankers with a dilemma. Raising interest rates to quell inflation might push the economy deeper into recession; lowering them to foster growth might send inflation spiralling out of control. Between October last year and July this year, the country’s rate-setters seemed to prioritise price stability, raising the benchmark Selic rate by three percentage points, to 14.25%, where it remains.

The alluring real rates of almost 5% ought to have made reais attractive to investors. Instead, the currency has lost two-fifths of its value against the dollar over the past 12 months. It is this pattern of a weakening currency and rising inflation despite higher interest rates, combined with a doubling of debt-servicing costs in the past three years (see chart), that has led to the diagnosis of fiscal dominance. The cost of servicing Brazil’s debts has become so high, pessimists fear, that rates have to be set to keep it manageable rather than to rein in prices. That, in turn, leads to a vicious circle of a falling currency and rising inflation.

Monica de Bolle of the Peterson Institute for International Economics reckons that the Selic should be 2-3 percentage points higher than it is in order to anchor inflation expectations. If the selic rose by that much, however, it might actually stoke inflation, by adding to the government’s already hefty interest bill and thus raising the risk of default—a prospect that would cause the real to slump and inflation to jump. Alternatively, the central bank could print money to buy government bonds. But such monetisation would itself fuel inflation. Either way, spooked investors would surely dump government bonds for foreign assets, speeding the currency’s fall and inflation’s rise.

Brazil has been caught in such a trap before, most recently just over a decade ago. In a paper published in 2004 Olivier Blanchard, the former chief economist of the IMF who is now at the Peterson Institute, found evidence that rate rises in Brazil in 2002-03 spurred inflation rather than reining it in. Prices were brought under control only owing to the fiscal restraint of Ms Rousseff’s predecessor and patron, Luiz Inácio Lula da Silva, who took office in 2003.

The situation today is different, Mr Blanchard stresses. Real rates are less than half what they were in the early 2000s and only about 5% of government debt is denominated in dollars, compared with nearly half back then. The central bank’s reluctance to raise the Selic further may have more to do with the impact on output than with fiscal concerns. Currency depreciation, too, could be down to general gloom about the economy rather than fear of default or money-printing. It has also made Brazil’s $370 billion in foreign reserves more valuable in domestic-currency terms—a handy cushion.