Now The Ball is in The Central Bank’s Court

BRAZIL ECONOMICS - Report 16 Nov 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

Although Precatórios PEC destructed the fragile fiscal framework, the reactions of the foreign exchange and interest rate markets have been moderately positive. The explanation is cynically simple: “It could be worse”. With this, the Real appreciated, closing last week at R$5.45/US$, and at the long end of the yield curve, the rates fell slightly below 12% a year.

Barring new surprises (such as the Supreme Court, under the guidance of Justice Gilmar Mendes, allowing a spending increase in an election year), for the Central Bank, the fiscal risk has ceased being a variable and morphed into a parameter. Its challenge now is to achieve its commitment to bring inflation to the target in 2022.

Since monetary policy operates with substantial lags, it is not only necessary for the SELIC rate to reach a “sufficiently restrictive” level at some moment, but rather that this be reached within a sufficiently brief time frame for its effects to occur during 2022. This requires a faster pace of elevating the SELIC rate. After describing the recent behavior of inflation, and presenting evidence of signs that the economy is decelerating, we present our estimates.

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