Stubborn Monetary Dogmas

Image: Magali Guimarães


Central Bank autonomy and inflation targets

I return to the issue of the Central Bank, patient reader. I count on your patience, perhaps a typically Brazilian characteristic. I return to the Central Bank because the problem it represents is seriously aggravated by the stubbornness of its president, who insists on keeping interest rates on the moon and takes time to signal the beginning of their reduction, already late, ridiculously late, since the various indicators relevant ones justify it more and more clearly. But today, I don't want to talk about the situation of Brazilian monetary policy, but the background, that is, the strategic issues that, although not always explicit, permeate the debate on currency and interest, not only in Brazil, but in other countries.

I am referring to two interconnected issues: the autonomy of the Central Bank and the inflation targeting regime. These are still revered policies, at least in Brazil, but very debatable, to say the least. They became dogmas since the early 1990s in much of the Western world, and ended up being imported by Brazil: the target regime in 1999 and the legal autonomy of the monetary authority in 2021. Our adherence to these dogmas, especially the second, was late. And perhaps that is why the chicken coop orthodoxy that prevails in the national economic debate clings to them, even if their decline is felt in the developed countries where they originated.

In fact, parenthesis, in Brazil today there is no economic debate. What exists is not exactly “debate”, but the unilateral dissemination of a single point of view. And it is not exactly “economic”, since the theses and opinions presented are vulgar versions of what is known as economics, be it pure or applied.


Origin of current monetary dogmas

In many countries these two dogmas, after reigning almost uncontested in the final decade of the XNUMXth century and in the first decade of the current century, survive today. pro forma, having been essentially abandoned in practice. “Autonomous” central banks are increasingly integrated into state economic policy. The vaunted autonomy, which was never full, exists today more in legal texts and textbooks than in reality. The targets regime, adopted as an “anchor” for monetary policy in many developed and developing countries, has been made more flexible and, in several cases, shelved without fanfare.

Even so, it is worth briefly reviewing the origin of these two monetary tenets. This will help to understand its application in the last three decades, as well as its survival difficulties in more recent years. I will try to be clear and exercise the spirit of synthesis.

If I could sum up in a few sentences the long-term historical trend of the institution of money, I would say that it is characterized by a slow and tumultuous trajectory towards something fundamental – the recognition that money must be a pure fiat state currency. Unanchored, therefore. An unbacked currency issued by a national state, as is almost always the case, or in a few cases by associated national states, as in euro Europe. The issuers, by state delegation, are always national or regional public central banks. The acceptance of the currency is a convention guaranteed by trust (fiducia) in the State ultimately responsible for its issue.

This long-term trend was imposing itself in the face of much resistance, motivated by habits and prejudices. Reluctance prevailed for a long time in accepting that the currency did not have an “intrinsic value”, as is the case with metallic coins, based on precious metals, notably gold and silver. However, the infeasibility of the gold standard, even modified and modernized, was wide open with the Great Depression of the 1930s, when it was confirmed that gold was nothing more than a “barbaric relic”, in the famous expression of Keynes.

Important remnants of the gold standard still survive in the fixed adjustable exchange rate system established in Bretton Woods, immediately after the Second World War, a system that had as its central aspect the free conversion of the dollar into gold at a fixed rate. With the moratorium enacted by the US government in 1971, unilaterally suspending the convertibility of the dollar into gold, we finally entered a pure fiduciary currency regime, as highlighted, among others, by Milton Friedman.

The delay in reaching this point is due not only to a savage attachment to the golden relic, but to something more persistent: the distrust of economic agents and a significant part of economists in relation to the economic role of the State and, therefore, resistance to accept an unanchored, inconvertible currency, based exclusively on confidence in that State. Then began a long period, still unfinished, in which efforts were made to ensure, by means of rules or anchors, that the state currency was truly trustworthy. Given the impossibility of basing the monetary and payment system on the primary issuance of private currencies, the option of imposing discipline on the issuing State remained.

The aspiration would prove much more difficult to realize than perhaps one might initially imagine. Simple rules would prove impracticable, given the complexity of economic reality. Complex rules, difficult to specify and lacking in transparency, would prove ineffective in generating the desired trust.


The failure of monetary and exchange rate anchors

What paths were followed to try to discipline the issuing State. One attempt, advocated by the same Friedman, was to establish a “monetary anchor”, that is, a rule or rules that quantitatively specified limits to the expansion of primary money or some other monetary aggregate. The relationship between issuance and inflation would, however, prove to be uncertain and unstable, making the experience with monetary anchoring ineffective. After years of theoretical and empirical controversy, Friedman himself and his followers, the so-called monetarists, would eventually be forced to retreat and abandon this approach.

Another attempt was to resort to exchange rate pegging, that is, to oblige the Central Bank to defend fixed rates or some pre-established rule for changing the exchange rate. A wide spectrum of exchange rules, from the currency board to wide currency bands, has been tested in several countries. The flat rate system established shortly after World War II, in Bretton Woods, lasted a few decades, but experienced increasing difficulties in the 1960s until it succumbed in 1971, as I mentioned. Currency pegging would have even more disastrous consequences in many developing countries, including here in South America, in the 1970s, 1980s and 1990s.

In the 1990s, Mexico, Argentina and the Brazil of the Real Plan, for example, experienced serious economic crises when trying this approach. The problem, in a nutshell, is that defending a particular nominal exchange rate or rule proved to be extremely costly in situations marked by broad freedom of capital movement. As it is practically impracticable to completely and forever abandon national autonomy in the management of monetary policy, the exchange rate peg ended up leading to major balance of payments crises, with heavy consequences for the countries that were led to follow this path.


The new anchors: Central Bank autonomy and inflation targets

What to do? Despite the failure of the monetary and exchange rate anchors, it was still inconceivable for the dominant economic thought to accept a pure fiduciary state currency, without strings and guarantees. The search continued for ways to limit the freedom of the State and thus give reliability to the currency issued by it. It was then that, mainly since the 1990s, the combination of two “institutional anchors” that crystallized into true dogmas and survived until today, albeit weakened: the autonomy of the Central Bank and the regime of targets for the inflation.

What did these two complementary ideals mean? And why would they also prove problematic as anchors? What they have in common and what makes them complementary, as I indicated earlier, is that they both constitute fetters or limitations on the power of the State. The Central Bank's legal autonomy removes the monetary authority's subordination to political power, granting the president and other directors long terms that do not coincide with that of the President of the Republic.

The declared objective is to “depoliticize” monetary policy, which would be guided exclusively by technical criteria. The short horizon of politicians would be replaced by the long horizon of an autonomous and specialized bureaucracy. The Central Bank would be free, in particular, from the so-called political cycle, which tends to translate into expansive policies in election years, to the detriment of economic and monetary stability.

The inflation targeting regime, in turn, imposes an additional limitation on the Central Bank, which is given the freedom to seek, by managing the interest rate and other variables, without government interference, numerical targets for the inflation rate. of inflation, generally determined by the government (by the National Monetary Council, in the Brazilian case). Once the goals are established, the government leaves the scene. The Central Bank conducts monetary policy on its own, being forced to focus its actions on a primary objective: the stability of the purchasing power of the national currency.

The targets regime can be more or less flexible, depending on how it is specified. Are the targets ambitious, do they require a great effort to contain them? Are they punctual or are there confidence intervals? Are the deadlines set for achieving the goals short? Is the reference variable headline inflation or inflation measures adjusted to exclude certain volatile components of the general price index? In certain aspects, the Brazilian regime was defined in a relatively flexible way when compared to that of other countries, which did not prevent successive non-compliance with the targets in recent years.


Discredit of the new anchors

I have tried to summarize above, without caricaturing, the orthodox arguments. There is a certain plausibility to these arguments, a certain appeal to common sense. But reality has repeatedly disappointed the expectations of those who defended them.

As for the Central Bank, it would soon become clear that monetary policy cannot be conducted independently of the rest of economic policy, in particular fiscal policy, as the Keynesian economists had warned. If the Central Bank, supported by its legal autonomy, wants to act on its own, without coordinating its steps with the Ministry of Finance and other areas of government, a certain amount of confusion is inevitable and nothing positive will result. The practical reality of economic policy, the interconnections between its components, recommends that the monetary authority act in combination with the government, exchanging information, discussing objectives, anticipating movements.

In short, the Central Bank is, always and everywhere, an arm of the state apparatus. A Central Bank that intends to be independent de facto, and not just de jure, becomes a hindrance to the conduct of economic policy. This rarely happens – the Brazilian case of 2023 is an example among few.

The idea of ​​an autonomous Central Bank has become especially problematic in times of intense political polarization in so many countries, including Brazil. In this environment, the non-coincidence between the mandates of the President of the Republic and that of the president of the Central Bank can make the command of the monetary authority a foreign body within a new government, as has been happening in Brazil after the inauguration of President Lula.

Roberto Campos Neto tries to technically justify his decisions, especially the exceptionally high interest rates, but his justifications are not solid and have been rejected by the government and by a growing number of politicians, economists, businessmen and even by people linked to the financial market. Almost unanimously negative. As the months went by, the “technical” position argued by the Central Bank seems increasingly unsustainable. In the official field, many have the feeling, correct or not, that the president of the Central Bank is an infiltrated Bolsonarist, who deliberately sabotages the government's economic plans.

This new problem, that of political polarization, overlaps with an old problem, of a structural nature, that economists like me have tired of pointing out: establishing the Central Bank's legal autonomy in relation to political power reinforces its capture by private financial interests. The counterpoint of government influence disappears or diminishes and the influence of financial capital, ensured by the famous revolving door, gains strength.

Members of the Central Bank's board of directors come, in large part, from the financial system and return there. Going through the command of the Central Bank is a way to burnish your CV and gain more advantageous positions in the financial market – provided, of course, that the executive dances rigorously to the music during his time at the Central Bank. A subtle form of corruption. The Central Bank, through these and other means, becomes chasse guardée of financial capital.

The second dogma, the inflation targeting regime, also revealed important flaws. Even when defined relatively flexibly, the regime often proves unwieldy. Targets that seemed reasonable when they were defined later turned out to be draconian, demanding high interest rates, with an impact on the level of activity, the exchange rate and public finances.

The problem here is one that always appears in the application of rules, whether fiscal, exchange rate, or monetary: the forecasting capacity of economists is poor. “The expected never happens; it is always the unexpected”, said Keynes. New facts, shocks of different types subject any scheme of rules to tensions that are difficult to manage. The great international financial crisis of 2008-2010, the Covid-19 pandemic, the war in Ukraine since 2022 have put pressure on inflation targeting regimes.

The heavy impact of this succession of financial, political and supply shocks led to a general erosion of confidence in the usefulness of this regime, even in its most flexible versions. Supporters thinned, critics grew more vocal. Many central banks have quietly abandoned the monetary model. The targets were made more flexible in such a way that the regime became virtually indistinguishable from pure discretion, that is, very close to the model of pure fiduciary currency, unanchored, without ballast.

Here in Brazil these monetary dogmas find, however, a final refuge. As Millôr Fernandes used to say, when ideologies get old, they come to live in Brazil. Dead and buried in the rest of the world, they gain a final survival here.

*Paulo Nogueira Batista Jr. he holds the Celso Furtado Chair at the College of High Studies at UFRJ. He was vice-president of the New Development Bank, established by the BRICS. Author, among other books, of Brazil doesn't fit in anyone's backyard (LeYa).

Extended version of article published in the journal Capital letter, on June 30, 2023.

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