Mauro Rochlin: Understand why inflation soared in 2021

Inflation, measured by the IPCA (National Broad Consumer Price Index), was 10.06% in 2021. This is the third worst result among the 20 largest economies in the world. We are only better than Argentina and Turkey. Analyzing the bad result of 2021 makes it possible to recognize any mistakes made in the conduct of economic policy, which will help us to avoid them in the future.

Three factors are mainly responsible for the inflation in 2021: the sharp rise in commodity prices, the soaring dollar that took place in 2020 and the imbalance of global production chains. Let us see, therefore, how these factors emerged and how, as a consequence, there was a strong pressure on prices in Brazil.

The rapid resumption of demand for commodities has resulted in a sharp rise in prices since the last quarter of 2020. The “V” recovery of the world economy has generated increasing pressure on so-called strategic raw materials, such as oil, gas, iron ore of iron and wheat, impacting several production chains. Expansionary fiscal policies, combined with very generous monetary policies, played a central role in this movement.

Second, the unbridled rise of the dollar in 2020 has strongly affected Brazilian industry costs. As the sector is very dependent on imported components, the rise in the US currency impacted the costs of important local productive segments. In 2021, the reflexes in retail were present. In addition, so-called tradables such as soybeans, rice and meat were also greatly affected.

The cause of the lack of exchange control was a rather reckless fiscal policy. The lack of predictability of government spending policy exacerbated investors’ risk aversion, which ultimately affected the dollar. In fact, this was certainly the main error in the conduct of economic policy.

Finally, the disarray of global supply chains, as a result of the mandatory stoppage imposed by the pandemic, by restricting supply at a global level, has also hit prices. Semiconductors, electrical and electronic material, chemical products, fertilizers and other intermediate goods whose production processes had been interrupted registered significant increases. The effect these supply chains bore has turned into supply-side cost pressure.

Despite this somewhat gloomy picture, it is also worth pointing out the reasons why the market expects lower inflation in 2022.

More expensive credit is the first reason. The Selic rate should surpass the level of 11% in 2022. The combination of high interest rates and high inflation led to an accommodation in household consumption. This is what GDP (Gross Domestic Product) for the third quarter of 2021 reveals. Given the high correlation between consumption and inflation, the logical conclusion is that the retraction in demand should help contain prices in 2022.

The stable exchange rate is the second factor. Despite still exhibiting strong volatility, the US currency is relatively stable in the annual comparison. If the dollar exchange rate remains constant, and that depends on the conduct of our fiscal policy, there will be no inflationary pressure on account of imports and tradables.

The third reason is stability in commodity prices. In the quarter ended in December, after four quarters of increases, the Dow Jones Commodity, the index that measures the change in prices of the main raw materials traded on the Chicago Commodity Exchange, remained unchanged. If this remains the case, the chances of a more favorable inflationary horizon increase.

The last factor is the robust, albeit slow, recomposition of global production chains. With the end of the stoppage resulting from the pandemic, production bottlenecks are being overcome. As a result, the impact that these supply chains have suffered, in terms of costs, tends to soften, which should alleviate inflationary pressures arising from supply.

In short: in 2022, inflation, measured by the IPCA, should fall!