By PAULO NOGUEIRA BATISTA JR.*

Usury as a state policy is not a technical matter – it is a political option. As long as Brazil leads the rankings of inequality and real interest rates, it will remain hostage to a system that transfers wealth from labor to capital, from the public to the private, from the future to the present.

Today I will address a particularly complex economic issue – the Central Bank’s interest rate policy. The article will be a bit more technical. However, don’t give up, reader. If you have difficulty with a paragraph or technical term, skip the passage and continue, or do some quick conceptual research online.

Since last year, under the Roberto Campos Neto administration, and in 2025, under the Gabriel Galípolo administration, the Central Bank has significantly increased the basic interest rate, the Selic. Real interest rates former before (the nominal rate discounted from expected inflation) rose to record levels, placing Brazil, once again, as the world champion or runner-up in usury.

At the last meeting of the Monetary Policy Committee (Copom), the Central Bank leadership indicated that interest rates will remain high for a long time, adapting more or less passively to the expectations of the financial market.

These moves by the Central Bank sparked intense controversy in the country. Many were against it, many were in favor. Who is right? The financiers, rentiers and market economists, who usually defend high interest rates? Or the industrial sectors, other productive sectors and more heterodox economists, who reject the Central Bank's policy? As the reader probably knows, I am in the second camp.

The issue is more complex than is generally imagined. Assessments should therefore be made with a certain degree of caution, which is rarely the case. The usual exchange of slogans and adjectives produces, as always, more heat than light.

But this caution will not prevent me from being incisive in the article's conclusions.

Does a high interest rate policy really reduce inflation? At what cost?

Some initial questions: can high interest rates really control and reduce inflation, as their advocates often claim? And, if so, at what cost in terms of adverse effects on GDP, employment, public finances and distribution of national income? Is this an effective policy? Is it also efficient?

There is little doubt that high interest rates generally contribute significantly to reducing inflation. Through at least three channels. First, they compress aggregate demand for consumption and investment in the economy, which exerts downward pressure on the prices of goods and services that are not internationally tradable (non-tradeables), including on remuneration for work.

Secondly, because they tend to cause exchange rate appreciation, which depresses the prices in reais of internationally traded products (tradeables), both exportable and importable. Third, because the rise in basic interest rates, if seen as sustainable, normally reduces inflation expectations and, in this way, tends to reduce current inflation and long-term interest rates. Thus, a high interest rate policy is normally effective in reducing inflation.

However, this does not mean that it is efficient, as several factors limit its anti-inflationary effects and produce adverse side impacts. It is effective because it generates a drop in inflation; but it is not efficient because it achieves this result by producing great damage and side effects.

Let us look at some of these factors. In a continental economy such as Brazil, the degree of external trade openness, measured by the ratio of foreign trade flows to GDP, is lower than that observed in small, open countries. In small countries such as Switzerland, Belgium or the Netherlands, among many others, where the degree of openness is very high and almost always well above 100%, the external appreciation of the national currency induced by high interest rates has a decisive impact on inflation.

In the case of Brazil, which has a degree of openness of around 40%, the anti-inflationary impact of an external appreciation of the real, although not negligible, is rarely decisive. (Incidentally, in the United States, another continental economy, the degree of openness is even lower than ours, less than 20%).

In other words, the exchange rate appreciation required to obtain a certain reduction in inflation is greater in countries like Brazil, which tends to undermine the international competitiveness of the economy and generate an imbalance in the balance of payments in the current account.

A second aspect of the issue: there is always some rigidity in prices and wages when falling. In economies like Brazil, which have a long tradition of indexation, there is also some inflation inertia, that is, the tendency to bring past inflation into the present. Thus, the anti-inflationary effect of a given contraction in aggregate demand is smaller than it would be if prices and wages were more flexible and the inertial component of inflation were smaller.

In short, for these and other reasons, a significant contraction in demand and/or a significant appreciation of the exchange rate is needed to reduce inflation and bring it within the target, especially when this target is set in an overly ambitious manner. This is what we have today – a legacy of the incompetent economic management of Michel Temer's government, which was led by a supposed "dream team”, as it was said at the time in relation to the Treasury and the Central Bank.

The Lula government should have increased the central inflation target and the range around it, as President Lula wanted. Nothing was done, however. The fear of displeasing the market prevailed in the economic area.

Effects on public finances and the distribution of national income

High interest rates produce destructive side effects. In addition to slowing down the economy, they destabilize public finances in two ways – directly (by increasing the cost of public debt) and indirectly (via the adverse effects of the decline in the level of activity on revenue and cyclical spending such as unemployment insurance).

The public sector as a whole currently bears net interest expenses of around 8% of GDP! This component, and not the much-vaunted primary fiscal result, is what explains the public deficit and the growth of government debt. The primary deficit is around 0,6% of GDP.

And the problem doesn't stop there. When the government pays scorching interest, who receives it? Who are the government's creditors? Basically, financial institutions, the super-rich, the wealthy and, to a lesser extent, the upper middle class, as well as foreign creditors.

High interest rates are, in fact, a powerful instrument for concentrating income in a country that has long been the world champion or one of the world champions in terms of social inequality.

It is also worth noting that this monetary policy places reais precisely in the hands of those who are highly prone to capital flight in times of uncertainty, such as at the end of 2024 – a flight facilitated, it should be remembered, by the premature liberalization of the capital account, a regrettable legacy of the Fernando Henrique Cardoso administration. This feeds the monster of destabilizing currency speculation with generous interest rates. The country suffers and the money-grubbing crowd celebrates.

No one is asking the new leadership of the Central Bank to make a U-turn on monetary policy. But, frankly, status quo?? Keeping everything as it was in the previous administrations of the institution??

*Paulo Nogueira Batista Jr. is an economist. He was vice-president of the New Development Bank, established by the BRICS. Author, among other books, of Shrapnel (countercurrent) [https://amzn.to/3ZulvOz]

Extended version of article published in the journal Capital letteron July 04, 2025.

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