Economists err in the pandemic and call into question the projection model

Institutions and economists from the public and private sectors, in Brazil and in other countries, had difficulty in projecting the behavior of the economy in this second year of the Covid-19 pandemic.

In 2020, the health crisis led to a negative surprise, mainly in the GDP (Gross Domestic Product) data. In 2021, the central issue was price indices, with unexpected inflation, also linked to the pandemic.

The sanitary crisis has caused supply bottlenecks, changes in input prices and changes in baskets and consumption patterns that call into question the projection models used by economists and public authorities.

It also led governments to adopt stimulus programs at levels never seen in recent decades, causing distortions in investment and savings decisions.

At the end of last year, the general expectation was for world economic growth this year to be lower than currently estimated. The advance of vaccination, although problematic in many countries, and the reopening of several activities changed this scenario. They led to an optimism at the beginning of the second half, which is now starting to be partially reversed.

The biggest mistake, however, was that virtually no one — not even central banks — expected such a strong and persistent return to inflation. Nor the need to reverse various stimulus measures, including a wave of interest rate hikes in several countries.

In the case of Brazil, both inflation and the basic interest rate should close the year at a level that is practically triple what was expected at the end of last year.

The scenario in December 2020 was a growth of 3.4% for the economy, with inflation of 3.3% and a basic interest rate (Selic) of 3% at the end of 2021, considering the economists participating in the survey Central Bank Focus.

These estimates do not differ much from those made by the Central Bank and Ministry of Economy for GDP (Gross Domestic Product) and inflation. Nor what is projected by the IMF (International Monetary Fund) for growth.

More recent forecasts and data show that GDP should increase by around 4.5%, with an IPCA close to 10% and the Selic rate of 9.25% per year.

At the end of last year, the BC even projected an alternative inflation scenario at 6.4% in “a situation of significant deterioration in the perception of the fiscal situation” of the country in 2021, using as a reference the exchange rate variations and country risk of 2014 to 2016, at the end of the Dilma Rousseff government. The current situation, however, turned out to be worse.

Central banks in other countries, including the US, also spent a good part of the year arguing that inflation was transitory, linked to bottlenecks caused by the pandemic that should dissipate in 2021, but they have already changed their speeches and started to review their monetary policies.

IMF inflation expectations went from 1.3% to 2.8% in advanced countries and from 4.2% to 5.5% in emerging countries, according to the most recent estimate, from October.

Marco Caruso, chief economist at Banco Original, says that the projection models use some variables that cannot be observed, but only estimated, such as the output gap (difference between actual GDP and its potential) and neutral interest.

According to him, the sequence of economic crises the country has gone through in the last decade, added to the uncertainties brought about by the pandemic, make it necessary to doubt these variables a little more.

It is possible, for example, that the neutral interest rate has become higher. With that, he says, perhaps the Selic rate of 2% per year adopted during much of the pandemic was much more stimulating than projected at the time.

This would, consequently, lead to higher inflation in the horizon when the effects of interest rates are felt more intensely, in general, after about nine months — the BC started to raise interest rates in March of this year.

“The uncertainty is so great that I need to doubt my basic model a little more. Maybe I have to give more weight to alternative models, which take into account basket changes [de consumo], greater persistence of shocks, etc.”, says Caruso, whose institution is in the BC’s ranking of economists with the most correct inflation projections.

Throughout 2021, part of the financial market projections also departed from the industrial production, retail sales and service sector volume indicators released by the IBGE (Brazilian Institute of Geography and Statistics).

In part, economists attribute the frustration of the estimates to the pandemic, which spread uncertainty and brought volatility to the statistical models of the surveys. There was also the additional impact on economic activity caused by the succession of political turmoil.

With the episodes of tension led by the Jair Bolsonaro (PL) government, the dollar gained strength in the country, generating reflexes on the real economy that did not appear on the market’s radar initially.

Among them is the greater pressure of the exchange rate on inflation, which was already being impacted by the succession of supply shocks in the pandemic.

The rise in inflation is pointed out as one of the reasons for the loss of breath in economic activity in recent months.

“In fact, the pandemic ended up distorting patterns. You lose that seasonal relationship, the historical pattern. It takes a while to be adjusted. Statistically, it became more difficult to project”, assesses the chief economist of the Austin Rating, the risk rating agency, Alex Agostini.

“Internally, we have to remember that there is volatility in the political environment. Even if we have some scenario ready, the very troubled political environment is affecting expectations.”

In October, the most recent period with available data, analysts estimated a 0.8% increase in the median for industrial production, according to a survey by the Bloomberg agency. The result released by the IBGE was a drop of 0.6% in the month.

In retail sales, the situation was similar. Analysts projected an advance of 0.7%, but the result pointed to a decline of 0.1%. In September, the forecast for commerce was for a drop of 0.6%, but the drop was more intense, of 1.3% (the IBGE has already revised the data to -1.1%).

Part of the estimates for the services sector also followed this path. Analysts consulted by the agency Reuters projected a positive change of 0.1% in October. The IBGE number, however, showed a drop of 1.2%.

“No analyst, no matter how pessimistic they were at the beginning of the year, could see inflation approaching double digits at the end of 2021”, comments the chief economist of the AZ Quest manager, Alexandre Manoel.

“Of course, the political environment didn’t help. But the main cause for the projection errors was inflation, coming from successive supply shocks,” he adds.

For Caruso, from the Original bank, 2022 should generate new challenges for the projections. “We are going to see an effect of higher interest rates reducing activity, in addition to the uncertainty of the election year. On the consumption side, Brazil Aid tends to be a robust program. Income transfer, when permanent, usually turns into consumption. When it is temporary, savings”, he completes.

Economist Piter Carvalho, from Valor Investimentos, also sees a scenario of uncertainty in 2022.

“Analysts are in their role, trying to make projections. Who has a discrepant speech is the federal government, which does not see the GDP [Produto Interno Bruto] falling, which does not see hunger or deforestation.”