Monetary Policy – The Hour of Truth

BRAZIL ECONOMICS - Report 12 Oct 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

To satisfy the inflation target at the end of 2022, after having attained the level of 8.25% at the end of 2021, the Central Bank will have to raise the SELIC rate to 9.5% at the start of next year. The cost of a “sufficiently restrictive” monetary policy will be to keep the GDP gap open during all of next year, leading to mediocre growth.

If it were to decide on a looser monetary policy, the Bank would repeat the “mistake of 2011”, when it worked with an implicit inflation target higher than the official one, as if the neutral interest rate was lower than the level to balance aggregate supply and demand, causing a longer and deeper recession starting in 2014 than would otherwise have been the case.

Given the current fiscal fragility, which will tend to worsen in an election year, and considering the risks from the international economy, the probability of a higher terminal interest rate is greater than that of a lower terminal rate.

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