Alexandre Manoel and Mirella Hirakawa: Supply and fiscal policy shocks, the culprits for the inflation target burst

The IPCA (Broad Consumer Price Index), used by the BC (Central Bank) to measure official consumer inflation, rose 0.73% in December and accumulated a high of 10.06% in 2021, 4.81 points percentages above the upper limit of the inflation target (5.25%), established by the CMN (National Monetary Council). This exceeding the target ceiling forces the BC president to publicly disclose the reasons for noncompliance, through an open letter to the Minister of Economy.

If this proven insufficient performance becomes recurrent, the president and directors of the BC may be dismissed by the President of the Republic, at the request of the CMN and prior confirmation by the Federal Senate, according to the law that gave formal autonomy to the BC. But are there reasons to request this exemption? We understand that it is not, for at least two reasons.

First, as the BC president himself has already commented, monetary policy is a passing factor of fiscal policy. The exchange rate dynamics in 2021 was marked by the maintenance of a high level (away from its fundamentals), in part explained by market expectations about the direction of fiscal policy.

Second, there were adverse supply shocks from the effects of the pandemic and the Brazilian energy matrix. In global terms, the pandemic has changed the consumption habits of families, especially due to the fact that the more restrictive health measures direct part of the consumption of services to goods, since, by staying at home, families stop consuming services related to leisure and start to direct the consumption of services to goods. income available for consumption of furniture and electronics, for example.

In Brazil, in turn, for two consecutive years, there was an impact on energy generation from the effects of La Niña, which reduced rainfall in the region with the greatest storage capacity of the reservoirs.

If we consider that the bottlenecks in goods (the global supply did not match the increase in global demand), the increase in fuels and the water crisis (due to the increase in the electricity tariff flag), elements that were responsible for 10%, 50% and 3% of the total IPCA, respectively, we will see that 6.3 percentage points of the 10.6% IPCA in 2021 are due to shocks.

Another inference that this inflation above the target is a consequence of shocks can be seen from the comparison between Brazilian and American inflation in the years 2019 (before the pandemic) and 2021 (after the height of the pandemic). In 2019, US consumer inflation — as measured by the US Consumer Price Index (CPI) — was 2.3%, while the IPCA was 4.3%. A difference of two percentage points. In 2021, US inflation is expected to close at 7.1%, which will mean a three percentage point difference between the IPCA and the US CPI, very close to that of 2019, especially if we consider that the water crisis occurred only in Brazil.

These surprises and the noise in the communication contributed to the decrease in the credibility of the economic policy, which led the BC to accelerate the pace of monetary policy normalization and increased the market’s perception that fiscal policy would return to the level of real expansion of spending that existed prior to 2015. Thus, given the set of “villains” of inflation in 2021, the BC was left with less scope for its action.

Finally, the challenge of improving coordination between the Ministries of Economy and the Central Bank is notorious. An essential contribution to this improvement is the recovery of the perception that the last word on fiscal policy belongs to the technicians of the Economy, as well as the commitment of the Planalto with fiscal consolidation. If that happens, the BC’s task of bringing inflation to the center of the target will be less complicated.