Headquarters of the Central Bank, in Brasilia - 01/15/2015 (Ueslei Marcelino / Reuters)
The central bank's hands are tied and, at this point, lost the ability to exercise more aggressive action to fight inflation. The main tie is the recession, which should lead to a significant rise in unemployment next year. The Central Bank's directors can not even commit to a deadline for the fulfillment of the inflation target, which is 4.5%. In this scenario, it is unlikely to occur a significant drop from the 2016 price index.
This is the summary of analysis by economist José Júlio Senna, one of the greatest Brazilian specialists when it comes to monetary policy. Author of Monetary Policy: Ideas, experiences and Evolution (FGV Editora, 2010), Senna has been director of the BC and currently heads the central monetary research of the Brazilian Institute of Economics (IBRE) of the Getulio Vargas Foundation in Rio.
In an interview to Veja, Senna analyzed to combat inflation dilemmas in the country. His conclusion: the solution must necessarily go through the balance of public accounts.
It can tell if the worst of the recession is behind us?
I do not think so. Explain why. The projections indicate a fall in GDP of more than 3% this year and another next fall 3% in 2016. We are talking about a cumulative decline of around 6.5%. The unemployment rate, measured by continuous PNAD, rose from 6.8% last year to 8.5% on average this year. This high is closely associated with the greatest number of people looking for work, and not to a significant decrease of people employed. The drop in household income and the worsening outlook in the economy did these people who were outside the labor market, going to fight and try to get a job.The economically active population, whose growth stood at 1% per annum, is expected to grow 2% this year and also next. The employed population increased last year, 1.5%, despite the recession. This year, the employed population is expected to remain stagnant, while there will be more people in search of a job. The recent Brazilian experience shows therefore significant mismatch between economic activity and the labor market. There was also a reduction in the total of employed people, despite the recession already be with us for a long time. Possibly, employers are postponing layoffs, among other reasons because of labor costs. This adjustment, however, should take place in 2016. We expect a decline in the working population. The average unemployment expected to reach 11.5%. Design therefore increased by 3 percentage points in the unemployment rate. In this sense, the bulk of the crisis has not happened yet.
Therefore, believes that inflation is expected to wane in the face of recession and rising unemployment?
For many analysts, inflation is expected to fall next year. In 2015, the rate should be close to 10.5%. At average market projections, by 2016 it will retreat to 7%. Still above the official target of 4.5% but a significant drop compared to the current inflation. Who shares this prognosis think that the recession will drop strongly inflation. But we need to examine other factors such as the behavior of public accounts and inflation expectations. The fiscal framework remains expansionary. The budget deficit is a huge inhibitor Central Bank action. He ties the hands of BC. This is one of the three major chains that see the Central Bank actions.
What are these shackles?
There have been a debate on the possibility of Brazil being or not a fiscal dominance situation (situation in which rising interest rates worsening public accounts, exacerbates the perception of risk, depreciates the exchange rate, and further increases inflation, instead of reducing it). It is a very technical and specific term. It requires an analytical rigor to be featured. I can not say if Brazil is going through a fiscal dominance frame, but in any case the fiscal situation by inhibiting an end BC's most aggressive action to fight inflation. I give an example. Suppose the BC make their projections and find that you need to increase the Selic rate by 4 percentage points to reach your goal to control expectations of future inflation and make the index converge to the target of 4.5%. Suppose the Fed announce it, without that its action is accompanied by reforms and the balance in public finances. If the BC announce this goal, I fear that an interest rate hike of this magnitude can be very badly received by the market. There could be a worsening of prospects, making the Brazil risk rise. If the risk goes up, the real tends to depreciate. Depreciation is more inflationary pressures. The expected result of reducing inflation may possibly not be achieved. This seems to be a fact that inhibits the central bank to act more specifically to combat inflation through high interest rates. But I do not believe this is the greatest concern of the Central Bank's board.
What is the main strings, then?
Most tie is the recession. Who advocates a greater shrinkage of the economy're saying you're not happy with a cumulative decline of 6.5% of GDP. Understands that is necessary even deeper recession.
The third tie?
It is political in nature. Not that President Dilma phone directly to the president of BC to recommend that interest rates do not rise. But the president is fighting for his political survival. A high interest rates now would be very uncomfortable. Moreover, the manifestation of the politicians in Brasilia, the central bank is always charged for that interest not fall, and not why they do not go up. The bias goes in that direction, given the current recession.
It is therefore difficult to imagine that there will be an increase in interest rates, although inflation remains far from the target of 4.5%?
Cycles of high interest rates depend on a suitable timing. There are times when it makes more sense, there are times when it becomes difficult. Early in the second term of government Dilma, when there was the exchange of the Minister of Finance, the weather was in order to make the adjustment. Joaquim Levy needed a clash of expectations and gained strength the idea of bringing inflation to the target of 4.5%. The BC took advantage and made earlier this year, a correct policy of rising interest rates. There was a favorable climate, but this timing over. The political environment is much deteriorated, and the macroeconomic environment is horrendous because of the recession. These factors inhibit not only the BC raise interest rates, but also the Central Bank's own commitment to the inflation target.
José Júlio Senna former director of the Central Bank and partner at MCM Consultores (Bia Guedes / Agência O Globo)
You mean that the Central Bank can not commit regarding a term to bring inflation back to the target of 4.5%?
That's right. Before the Fed had indicated it would bring inflation to the target in 2016. Now this statement disappeared. The central bank had to give up this commitment; It may not indicate a deadline to achieve the goal. He said then that pursue convergence to the target in the relevant horizon for monetary policy. Thus, only gained time. He went on a tangent. Now, at the last meeting of the Monetary Policy Committee, even that it ceased to be included in the statement issued after the meeting. Thus avoided a formal commitment. Problem in a targeting regime, such as Brazil, public confidence in the goal of fulfilling a previously stipulated horizon is essential to coordinate expectations.
What effect, then, the uncertainty about the inflation trajectory?
The expectations are deteriorating precisely because the target system is not anchored. We lost the anchor. The BC is tied, you find it difficult to commit. Thus, inflation remains high even with the backdrop of recession and rising unemployment. We have the recessive effect on the one hand, and the worsening expectations of another. So my conclusion is this: I think unlikely that inflation in 2016 is significantly lower than 2015.
Has there been any change in signal at the last meeting of the Monetary Policy Committee of the Central Bank, the Committee?
Yes. BC leaders withdrew the statement the message according to which the stability of the interest base rate would be kept "by sufficiently prolonged period". With this, a rise in interest earlier this year can no longer be entirely ruled out. But this does not invalidate our reasoning. The central bank faces restrictions to be aggressive in its interest rate policy, to try to anticipate and avoid high inflation, to join new cycle high real interest rate. Some Selic rate adjustment aimed only to prevent any worsening of inflation expectations significantly reduces the real interest rate can actually happen, but that's not what we're dealing with.
What to do to rid the BC of current bonds and allow it to act decisively to control inflation?
The answer is fiscal. The problem in Brazil today is fiscal whole. The deficit in the public accounts is inhibiting economic activity. It is inhibiting the Central Bank. It is increasing inflation. Fiscal uncertainty is very large. Entrepreneurs do not know whether to be taxed even more, or if the spending cuts made by the government will be sufficient. As the budget adjustment is not made, the central bank can not act. Look who intriguing situation: the question is not whether or not the central bank may raise interest rates; he can not even commit to specific time horizon for the fulfillment of the inflation target.
