Opinion – Solange Srour: It’s not a good idea to change the inflation target

Amid expectations that inflation will remain above the top of the target for the third consecutive year and that monetary policy will remain restrictive, the debate on raising the target returns.

The justification is that, with real interest rates close to 6% or 8% (depending on the metric), it will be very difficult to avoid a GDP slowdown. Defenders of raising the target also argue that keeping interest rates high will harm the result of public accounts, either because they impact tax collection, or because they increase expenses with nominal interest, which would require a costly fiscal adjustment for the country.

But is the inflation target really the reason why real interest rates are so high? In my last article, I showed that there is no evidence that the Central Bank of Brazil (BC) is excessively conservative.

It is not new that high real interest rates are insufficient to bring inflation to low levels or credibility to the Central Bank. The problem is that, even with all the institutional advances, every now and then we flirt with a sharp increase in expenses. The most recent episode was the Transition PEC, which, in addition to stimulating demand in an economy with no idle capacity, established the end of the spending cap —precisely the fiscal rule that made it possible to substantially reduce our risk and the subsequent drop inflation and interest rates on a prolonged basis.

It is no coincidence that inflation expectations in the Focus survey for 2023 and for the following three years began to rise with the discussion of the PEC and its subsequent approval. The fear of a debt sustainability crisis has returned, which is generally accompanied by the risk of higher and non-passing inflation.

It is astonishing to see economists defending the increase in the target, precisely because we have a rigid fiscal policy and have not advanced in reforms. Subliminally, they favor the use of inflation as a fiscal adjustment variable.

Indeed, when government expenditures are not adjusted in line with inflation and revenues, the short-term adjustment succeeds. This is what happened when we froze civil service salaries and the value of Bolsa Família for some time.

The problem is that society begins to anticipate higher inflation and to incorporate this into political negotiations. From then on, only inflationary surprises can help the fiscal picture. The cost of the fiscal adjustment made through unanticipated inflation inevitably falls on the poorest, who do not have protection mechanisms against the so-called inflationary tax.

If expectations were not so relevant to determine future inflation (which is very intuitive, because if everyone expects higher inflation they will try to readjust prices and wages), it would be possible to argue that the Central Bank, faced with a higher target, could reduce interest to obtain temporary gain from activity. The “temporary” occurs because economic science establishes that there is no relationship between growth and inflation in the medium and long term. Growth depends on variables such as productivity, population growth, business environment, etc.

Expectations are not static. It is one thing to change the target when inflation is not consistently far from that target and the fiscal policy is sustainable, it is another thing to take such a measure because we have given up on advancing with reforms and want to postpone an imminent slowdown. It is not by chance that the expectations in the Focus report advanced even more in recent weeks, after the speeches of members of the government were interpreted as favorable to the change in the target.

If there are reasons to believe that the inflation target should be higher —due to structural changes in the economy—, let lower inflation be given before changing the target in order to preserve the credibility of the monetary regime.

As variable expectations are crucial in the BC’s projection models, it will end up tightening the Selic rate even more if the inflation target is changed. Even more: if for some other non-technical reason the Central Bank does not react to expectations, long interest rates will rise with the increase in inflationary risk. The BC controls short-term interest rates, not the medium and long-term ones that affect credit and GDP.

The option to increase the target is equivalent to preferring to tax the less favored with the inflation tax than to cut expenses, so how can we expect inflation to stabilize at 4%, 5% or 6%?

The maturation of the inflation targeting regime and important advances —such as the end of excessive subsidies by the BNDES and public banks, the creation of a spending ceiling, the approval of the Social Security reform— led to a significant decline in real interest rates. and inflation itself between 2017 and 2019. We run the risk of throwing all of this away at the same time.