In the world of central banking and monetary policy, words matter. Communication is crucial for the institution to communicate its next steps to the public. It helps to adjust expectations, reducing bumps in economic activity.
In Brazil, as in many other countries, monetary policy follows an interest rate rule. The Central Bank plans its actions so that the basic rate, the Selic, reaches a certain value. This value is fixed by the Monetary Policy Committee, the Copom, in its periodic meetings, with the main objective of ensuring price stability. As we follow the inflation targeting system, this means keeping it as close as possible to the target, which in 2022 will be 3.5%, with a tolerance interval of 1.5% up and down.
At the last meeting, at the beginning of the month, the Copom once again decided to increase the Selic by 1.5 percentage points. It will end the year at 9.25%. In fact, this move was fully expected, as the Central Bank had signaled it in the minutes of the previous meeting, in October. The minutes of the last meeting, in December, provide more information on the direction of the Selic in 2022. Specifically, the rise in interest rates should be more prolonged and aggressive.
Let’s go back in time to understand the evolution of Selic. In 2020, the pandemic hit the world economy. Here, it was no different: economic activity plummeted, and with it inflation, which entered negative territory. As a result, the Central Bank reduced the base rate to historically low levels. It started 2021 at an incredible 2% per year.
The Central Bank itself recognized, in its communiqués, monetary policy along these lines as stimulating. In other words, this low value would not be sustained in the long term. Throughout 2021, with inflation showing its claws and inflation expectations rising, the institution began a strong but very predictable rise in the Selic rate. Initially promoted increases of 0.75 percentage point.
But, with inflation and expectations still on the rise, it started to step up the pace in climbing the base rate, with increases of 1 percentage point. This movement was intensified with the deterioration of the fiscal outlook arising from the PEC dos Precatórios and the relaxation of the spending ceiling rule. As a result, Brazilian public debt is seen as more reserved by investors, who tend to demand higher interest rates to finance the Brazilian government. The Central Bank then followed this movement, increasing 1.5 percentage points in the last two Copom meetings in 2021. And it already promises a new increase in this magnitude for the first meeting of 2022, in which the Selic rate will reach double digits .
The Central Bank also started to recognize that monetary policy has reached the ground. contractionist, that is, it has surpassed its long-term level. This means that the institution is willing to sacrifice part of its economic activity to ensure that inflation doesn’t take off.
Despite all this increase in the Selic, the 2021 inflation target –​3.75% with a tolerance interval of 1.5%– will not be met by a large margin. In 12 months, it has already passed 10%. However, much of this year’s inflation stems from factors that have nothing to do with monetary policy, such as the water crisis, rising international commodity prices, lack of inputs on the international market and political instability in Brazil. In isolation, this target gap should not erode the Central Bank’s reputation and its ability to maintain price stability.
The risk to the institution’s credibility is if this process of high inflation spreads to other years. And we’re already seeing a worrying move to 2022, with expectations hovering around 5%, right at the upper end of the target’s tolerance range. To push these expectations down, the central bank needs to show more teeth. It is in this sense that the December Copom minutes bring more aggressive communication. The contractionary character of monetary policy should intensify.
Thus, we should expect the Selic rise process to be greater and longer throughout 2022.
Mauro Rodrigues (Professor of Economics at USP and author of the book “Under the Economist’s Lupa”) and the team from Why?
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I have over 8 years of experience in the news industry. I have worked for various news websites and have also written for a few news agencies. I mostly cover healthcare news, but I am also interested in other topics such as politics, business, and entertainment. In my free time, I enjoy writing fiction and spending time with my family and friends.
