Opinion – Solange Srour: De jure autonomy, but de facto?

At the end of the 1980s, the concept of independent central banks emerged as an institutional solution to separate the political cycle from the monetary policy cycle. By its very nature, monetary policy requires a long-term horizon because of the lag between policy decisions and their impact on economic activity and inflation. In contrast, the political cycle has a shorter time horizon.

By giving control of monetary policy to unelected technocrats, the US experience of high inflation from the previous decade, for example, would not be repeated. Such an argument was successful; since then, several countries have reformed their institutional structures to protect central banks against political influence and safeguard price stability.

International experience shows that a greater degree of central bank autonomy is associated with lower levels and lower volatility of inflation—without harming economic growth. However, we know that de jure autonomy (established by law) may not necessarily translate into de facto autonomy. Even when the law is explicit, the practice can be different.

One way in which politicians can try to maintain control of institutions is by placing “allies” in high-profile positions. This is possible even in relation to de jure autonomous central banks, since the nomination of their president, as well as those of their directors, is a choice of the President of the Republic approved in a vote by the Senate.

Ioannidou, Kokas, Lambert and Michaelides, in “(In)dependent Central Banks” (January, 2023), collected information on the appointment of 316 central bank governors in 57 countries between 1985 and 2020 and found evidence that in several cases these appointments became even more politically motivated after the adoption of de jure autonomy. Where de facto autonomy was undermined, the consequence was unequivocal: higher inflation and less financial stability.

When de jure autonomy is not enough to guarantee that the central bank is not captured by interests other than controlling inflation, the monetary authority loses credibility. A credible central bank has a greater capacity to influence inflation expectations and make the cost of disinflation lower (fewer lost jobs). If political forces are not sufficient to insulate the central bank from pressure, autonomy is de facto lost, even if maintained by law.

We are experiencing a historic moment in Brazil: it is the first time that we have a political transition with a de jure autonomous Central Bank. It is difficult to make a counterfactual of what would be the behavior of financial assets shortly after the election result if there was uncertainty about the command of the Central Bank. What we can say is that inflation expectations began to rise close to the approval of the Transition PEC and even more so with the beginning of rumors of changes in the target, not because of doubts about the command of the Central Bank of Brazil (BCB).

The BCB currently has the difficult task of bringing inflation, which is still quite high, close to the target. The monetary policy tightening already carried out is significant. However, this will not be successful if uncertainties about the direction of fiscal policy are not reduced, as these impact inflation expectations and, ultimately, inflation. Medium and long-term real interest rates, which most affect the activity’s performance, are also high because of doubts about the sustainability of the public debt (increase in the risk premium required by public debt holders).

There is a great chance that economic activity will weaken further in the coming months. But, instead of facing the causes of high interest rates, what we have seen are numerous attacks on the de jure independence of the BCB and noises about the two replacements in the institution’s board, already set to take place at the end of this month.

The BCB’s autonomy was the result of a broad effort by the Executive and Legislative branches and a long process of institutional maturation. The composition of Congress does not make the scenario of annulment of this achievement likely, but for autonomy to be in fact preserved, it is important that the new directors and, later on, the next president of the monetary authority enjoy credibility and trust in the markets. Only then will we reap the benefits of real autonomy: low inflation, lower interest rates and greater financial stability.