Opinion – Solange Srour: Predicting inflation is not always difficult

At the end of the year, it is always worth doing the exercise of revisiting economic forecasting errors and trying to avoid their recurrence.

In 2022, I believe that the first place in this ranking went to the assessment of the global inflationary process in 2021. At the beginning of 2022, many economists, including central banks, still expected that inflation would be transitory – the result of the disorganization of production chains and the high energy prices. In the US, in particular, the expectation was that inflation would end 2022 at 3.5%. The cumulative increase so far is not only nearly 7%, it is also widespread, and the US Treasury bond yield has gone from 0.25% at the beginning of the year to around 4.25%.

In Brazil, high inertia and weakened expectations led the Central Bank to initiate monetary tightening almost a year before the Fed. Even though at the first Copom meeting of 2022, inflation projected by the BCB was at 5.4% – close to the expected level now – the hypothesis for administered prices (which include gasoline and electricity) was for an increase of 6.6%. Today, the BC expects inflation of 6% for 2022, but a deflation of 3.6% for administered inflation! If it weren’t for the reduction in taxes and the drop in the international price of gasoline, inflation would be close to 8%.

Contrary to what many economists still claim, high inflation, in Brazil and globally, is not only derived from supply shocks, but also from demand shocks resulting from the combination of expansionist monetary and fiscal policies adopted at the outbreak of the pandemic, which led to unemployment rates to historically low levels and wage readjustments above productivity. Pressures on prices are widespread, with particular intensity in the prices of services.

And what is expected for 2023? Can we have as a perspective that inflation will ease well, since in most of the world interest rates are less stimulating and in Brazil, specifically, they are at a very restrictive level? The answer must be: it depends, for the simple fact that there are many doubts about the fiscal policy of several economies, from Europe to China.

The effects of fiscal policy on inflation are generally divided into two. First, public spending generates demand for goods and services and –when the economy is close to full employment, as is the case in the US and Brazil– put pressure on installed capacity and the job market, causing inflation to rise. Second, when fiscal expansion is strong enough to raise the prospect of debt unsustainability, pressure on prices comes with exchange rate depreciation and the weakening of longer-term inflation expectations.

We enter next year with a fiscal expansion contracted by the Transition PEC of around 1.7% of GDP and with the determination that a proposal for a fiscal rule be sent to Congress which, if approved, will end the spending ceiling. Not to mention the other recently approved grants –and very well documented in an article by Marcos Lisboa and Marcos Mendes recently published in the Brazil Journal– which could increase the bill to more than 2% of GDP.

Some advocates of these fiscal expansion measures argue that we shouldn’t worry about the pass-through of fiscal policy to inflation. They say that a large part of this amount will be directed to the poorest, who have little capacity to consume and generate inflation. No matter how meritorious the reduction of social inequality may be, we would have to reinvent economic science in order to differentiate “good spending” from others in terms of aggregate demand. It was not by chance that the Selic rose from 2% to 13.75% with the tripling of social spending, and its effect on inflation is still very incipient.

Additionally, without considering the impacts of increased uncertainty about what the fiscal framework will be, the increase in contracted spending will imply an increase of almost 5 percentage points of GDP in the public debt over the next 12 months. In this regard, an argument often used is that there is no reasonableness in the concept of solvency in a country whose debt is denominated in national currency. After all, it is always possible to print currency to pay creditors. The idea that central banks can finance national treasures was buried in the world, but it survives in Brazil.

If the year 2023 does not bring a credible fiscal framework and compensatory measures for such an expansion in spending, it will not be difficult to predict what will happen to inflation. Likewise, it will not be difficult to predict the justification for the failure to control the public deficit: high interest rates and the “ambitious” inflation target