In the midst of negotiations by the elected government of Luiz Inácio Lula da Silva (PT) to increase spending via the Gastança PEC (proposed amendment to the Constitution), the Central Bank claims that the impact of “significant fiscal stimuli” tends to be greater on the inflation than on economic activity in an environment of low idleness.
The assessment appears in the minutes of the Copom (Monetary Policy Committee) published this Tuesday (13), referring to last week’s meeting. The document also points out that the tax issue was discussed “at length” at the meeting.
“In an environment of reduced output gap, the impact of significant fiscal stimuli on the inflation trajectory tends to overlap with the desired impacts on economic activity”, he said.
The output gap is the margin that the activity has to grow until it reaches its maximum capacity. The minutes state that the BC observed a reduction in the degree of idleness in the third quarter due to data revisions and disclosures of domestic variables. However, given the effect of the cycle of high interest rates, the Central Bank assesses that the gap should grow ahead.
For the monetary authority, the existence of idle capacity in the economy and confidence in debt sustainability are determining factors for an expansionist fiscal policy to achieve the desired impacts on activity.
The document also warns that the tax may affect the country’s neutral interest rate.
“The Committee judged that there is still a lot of uncertainty about the prospective fiscal scenario and that the moment requires serenity in the assessment of risks. The Committee reinforces that it will continue to monitor future developments in fiscal policy and their potential impacts on the dynamics of prospective inflation”, he stated. .
The BC decided to keep the Selic rate at 13.75% per annum in a meeting last week, when it sent messages to the elected government by saying that there is “high” uncertainty about the future of the country’s fiscal framework and stressed that it will closely monitor the situation of public Accounts.
Lula’s team in the transition is negotiating with Congress the approval of a PEC that could allow an increase in expenses of more than R$ 160 billion in 2023 and 2024 – the text is still being processed and may be changed. The objective is to pay for the expanded Bolsa Família, recompose expenses of ministries and expand public investments.
The expectation of increased expenses, associated with the signals of an economic team composed of names more aligned with an expansionist fiscal policy, brought down the Stock Exchange this Monday and pressured the dollar upwards. Investors fear that the future Lula government will be more interventionist, closer to the approach adopted in his second term, than in his first.
This Tuesday, the future Minister of Finance, Fernando Haddad, is expected to announce the first names of assistants in the portfolio.
NEUTRAL RATE
The document repeated the October Copom meeting by stating that fiscal policy can affect inflation through aggregate demand, asset prices, degree of uncertainty in the economy and inflation expectations, but now it includes one more element that can be impacted: the neutral interest rate—which neither stimulates nor contracts activity.
In its last Inflation Report, the Central Bank considered the neutral interest rate at 4% per year. A new edition of the document will be released on Thursday.
An eventual increase in the country’s neutral interest rates could force the BC to operate with a higher Selic level than previously estimated to bring inflation to its targets.
In the view of XP economist Tatiana Nogueira, the minutes brought tougher elements in comparison with last week’s statement, although it does not bring news in relation to the signals about its balance of risks.
🇧🇷[O BC] included one more channel that fiscal expansion has [de impacto] about inflation. […] He included the neutral interest as well. More fiscal spending makes the neutral rate higher,” he said.
The monetary authority also assessed that recent data reinforce the committee’s expectation of a slowdown in the pace of economic activity in the country, which should increase in the coming quarters.
Amidst the uncertainties, the BC pointed out that its inflation projections had a slight increase in the relevant horizon, due to the increase in projections for market prices in shorter terms and a revision of the projection of administered prices in longer terms.
“With regard to 2024, the Committee noted with concern a rise in average expectations,” he said.
In last week’s communiqué, the BC informed that, in its reference scenario, inflation estimates are at 6.0% for 2022 (against 5.8% in the previous meeting), 5.0% in 2023 (against 4 .8% before) and 3.0% in 2024 (against 2.9%).
The targets for the IPCA are set at 3.50% for this year, 3.25% in 2023 and 3.00% in 2024, with a tolerance margin of 1.5 points more or less in the three cases.
The document points out that some Copom members noted benign movement of commodities in reais and highlighted risks of further decline ahead, while other members emphasized the volatile nature of these prices in an environment of pressured inventories.
“Everyone evaluated that the current inflation did not surprise in a relevant way in relation to the expectation or substantially altered the understanding regarding the future dynamics of inflation”, he said.
The Copom also assessed the speed of the global disinflation process, pointing out that this movement may become slower, despite a relaxation in pressures on production chains and a drop in commodity prices.
“In view of the spread of inflationary pressures for the services segment, which has a more inertial nature, in a tight labor market environment in several countries, the disinflation process should be non-linear and slower than that observed in recent episodes”, said.
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