Monetary Policy: Continuation of the “Partial Adjustment” Cycle

BRAZIL ECONOMICS - Report 10 May 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

Last week, the COPOM raised the SELIC rate by 75 basis points and promised (with some reservations) an adjustment of equal magnitude at the meeting in June. With respect to the overall size of the cycle, however, it continued affirming that it will pursue a “partial adjustment”. Since its task will only be concluded when the GDP gap is closed and inflation (actual and expected) is equal to the target, this insistence on a partial adjustment is at least evidence that the Committee is insecure regarding the speed of the adjustment of demand (actual GDP) and supply (potential GDP). The current economic cycle is different from all others because there are shocks affecting both aggregate demand and supply. Last week, for example, the press gave the same emphasis to the effects of the shortage of raw materials for manufacturing, which limits output, as to the COPOM’s communiqué. The communication from the Central Bank would gain informational quality if it explained that it is committed to an (inevitable) full adjustment, but that in light of the uncertainties (which ones in its view?), this adjustment will not be completed in 2021. To guarantee anchorage of expectations, however, a substantial part of the adjustment will have to occur in 2021, taking the SELIC rate to 5.75% at year end. In the rest of this Report, we analyze the origin of the main pressures on inflation (exchange rate, commodities and monitored domestic prices), make a brief incursion in the controversy regarding the exchange rate, and conclude with some evidence about the frictions imposed by the pandemic both on aggregate demand and supply.

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