The “Floating Fiscal Anchor” and Its Consequences

BRAZIL ECONOMICS - Report 23 Aug 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

In the past several weeks, the risk premiums have grown significantly, accompanied by a marked increase of the entire structure of the yield curve and renewed weakening of the Real. The main factor underpinning this reaction is the realization that the spending cap has become a “floating fiscal anchor”, whose level grows to accommodate rising spending. The frequent changes in the laws that establish the fiscal limits are proof of the huge capacity for adaptation to political pressures, with unfavorable results.

Thus, the Central Bank cannot count on the support of fiscal policy to contain inflation. The tighter monetary policy will lead to growth below the potential level in 2022, and this trend will be accentuated by the deceleration of the global economy. We end this report with comments on the distribution of the costs of economic deceleration on the poorest members of society. Due to the low growth, the unemployment rate will likely increase steadily in 2022.

Since the pass-through of a weaker exchange rate is very strong for wholesale prices of agricultural products, which determine the evolution of the cost of the “food consumed at home” group, which has a high weight in the IPCA, the tendency will be for aggravation of the situation of low-income households. In an election year, this set of factors will accentuate the populist stance of the government, translating into new fiscal pressures and increases of the risk premiums, closing a vicious circle.

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