Stronger Growth and Higher Inflation: The Central Bank’s Reaction

BRAZIL ECONOMICS - Report 16 May 2022 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

Both because Brazilian growth benefits from higher international commodity prices and because the government has been using fiscal and credit stimulus policies to expand demand, economic activity began the year on the upswing. The most recent data indicate that growth in the first quarter was 1.3%, leaving a positive carry-over of 1.6% to the rest of the year. After a review of the most recent data on activity, which confirm that GDP growth in 2022 can reach 1%, we analyze the behavior of inflation and the reactions of monetary policy.

We show that after a long period when the neutral interest rate implicit in the Central Bank’s reaction curve was below the neutral rate implicit in the responses of economists to the Focus survey, the three last increases of the SELIC rate (two of 100 basis points and one of 150 points) have put these two estimates on an equal footing of around 4% in real terms. However, for all of 2020 and a good part of 2021, the Central Bank behaved as if the neutral real rate was fluctuating between 0 and 2%, while the perception among economists in the financial market was of a higher neutral real rate. In other words, in most economists’ perceptions, the Central Bank penalized the GDP results below the potential more than the deviations of inflation above the target.

With this, the expectations became unanchored, favoring increased inertia and pushing inflation upward. Despite this lapse, since the end of 2021 the one-year ex ante real interest rate has been hovering around 7%, characterizing restrictive monetary policy, which should cool off the economy to reduce inflation. Although inflation should fall, it will be unlikely to reach the target in 2023, and the SELIC rate will probably only start to be reduced after the middle of next year.

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