Opinion – Solange Srour: Price stability must be an end in itself

Inflation in Brazil reached 11.3% in March in 12 months – the second highest index since the beginning of the inflation targeting system. The phenomenon is not unique to us: the inflationary surge is global. However, the fact that inflationary pressures have aspects that are common to different economies does not completely define their causes or the way in which central banks should act to bring them back to much lower levels. Nor should it serve as a main argument to raise the inflation target or to defend the search for slower convergence.

The peculiarities of Brazilian inflation should instigate a greater debate not only about its determinants but mainly about how we can get prices under control again, enabling lower real interest rates and recovery of economic growth.

Pressures on prices are widespread, and all core measures that seek to capture the price trend by minimizing temporary shocks are at their highest levels since 2004. The secondary effect of the commodity boom reached all IPCA groups, and expectations of medium and long term distanced from the goals. Expected break-even inflation on government bonds for the next five years is at 5.9%—almost double the long-term target of 3.0%.In Brazil, the effects of the external shock were exacerbated by economic policies that weakened our anchor (expenditure ceiling) and an extremely stimulating monetary policy (Selic at 2%) —all of them responsible for a significant depreciation of the exchange rate.

Even having started to raise interest rates at a strong pace (0.75 percentage point), the diagnoses that the upward pressures were temporary and that the persistence of inflation had structurally dropped nourished the Central Bank’s expectation of that the rise in interest rates could be rapid, but with less intensity. As reality turned out to be different, expectations began to react more to current inflation, and the Central Bank had to adjust its communication throughout the tightening process.

We are facing an expectation of inflation close to 8% for this year (whose target is 3.5%) and 4.5% for 2023 (whose target is 3.25%). The current discussion already addresses how and when the Central Bank will admit that it will not be possible to reach the goal in 2023, reducing the pressure for monetary policy to remain restrictive for a long time.

A similar situation occurred in June 2016, when the BC’s new management resisted not adjusting the 2017 target. At that time, we had inflation well above the target, after a strong deterioration in the economic policy mix, a worsening of the fiscal imbalance and disorderly expansion of public credit. With the rapid reorientation of economic policy to orthodox pillars, the goal not only proved to be feasible, but was also broken down its band.

The current moment is one of exceptional uncertainty. On the one hand, the central banks of developed countries are beginning to tighten their monetary policies – which could generate a strong depreciation of emerging currencies and increase the risk of a recession in the US and a drop in commodity prices. On the other hand, the effects of the war in Ukraine are far from being fully mapped: accelerated energy transition, questions about the continuity of the dollar’s sovereignty and impacts on global growth.

To top it off, new disruptions in global production chains as a result of the lockdowns in China tend to put pressure on industrial prices for a while.

With the Selic rate at 11.75% per year, we are less fragile than we were in 2020. However, given the lack of clarity about the future determinants of inflation, including the impact of the current monetary tightening on GDP, it is recommended that we try to reach the end of the monetary tightening cycle pursuing monetary stability as an end in itself. Whether or not an additional adjustment to the current Selic is sufficient to control inflation, only the evolution of current uncertainties will tell.

To think that moderate inflation (around 5%, for example) will not bring great harm to long-term growth is very risky, especially in a country with indexation mechanisms and without stable fiscal rules. A 3% inflation target may be credible, depending on economic policy from 2023 onwards.

Arguing that the country is very susceptible to shocks or that it does not yet have an adequate fiscal framework for low inflation will only increase the vulnerability of our economy and make it difficult to achieve price stability.