By HENRIQUE MORRONE, ALESSANDRO MIEBACH & ADALMIR MARQUETTI*
There is little room for changes in monetary policy in the short term, even with the new presidency at the Central Bank
Traditional conceptions of macroeconomics, forged over forty years ago, suggest that monetary policy should occupy a central position in macroeconomic management, while fiscal policy is limited to acting through automatic stabilizers, which result from changes in public spending in response to fluctuations in the level of activity.
In this context, the term “fiscal dominance” has gained relevance in discussions about Brazil. The fear is that the country will enter a situation in which fiscal policy will override the power of monetary policy. This scenario occurs in contexts of deep fiscal imbalance, when public deficits translate into high inflation rates, which weakens the effectiveness of monetary policy.
Monetary policymakers are forced to adopt drastic measures, such as raising interest rates, in an attempt to control inflation. However, by raising interest rates, the fiscal deficit tends to grow, worsening the economic situation and generating more inflation. This can lead to an outflow of resources from the country, resulting in greater currency depreciation and intensifying the inflationary effects.
However, this interpretation of how the economy works has limitations. First, the effectiveness of the inflation targeting system can be questioned, since both countries that adopt this system and those that do not have managed to reduce their inflation rates. In this context, trade liberalization may have played a more decisive role in controlling inflation than the targeting system itself.
Furthermore, as André Lara Resende argues, it is possible that interest rate hike policies, through reverse causality, induce economic agents' expectations towards a high inflation trajectory, instead of reducing it.
Second, the primary deficit can generate an increase in real GDP, through the multiplier effect of public spending, as stated in Keynesian theory. In an environment of moderate interest rates, this could even reduce the debt-to-GDP ratio. The public deficit can have both nominal and real effects on the economy, promoting economic growth.
Third, the maintenance of very high interest rates by the Central Bank can paralyze the economy, especially when the search for fiscal surpluses is necessary to contain the increase in the debt-to-GDP ratio. According to the theory of functional finance, if the interest rate were reduced and remained below the impact of fiscal policy on GDP, the public deficit could result in a fall in the debt-to-GDP ratio. Debt would grow at a lower rate than GDP, causing the debt-to-GDP ratio to decline over time.
Fourth, if investors are to adopt a rational approach, they should be primarily concerned with the amount of international reserves. After all, it is international reserves that guarantee the country's ability to honor external commitments and allow investors to withdraw their resources during periods of economic instability.
Finally, fiscal dominance may function analogously to crowding out international, where fiscal imbalance causes inflation, capital flight and exchange rate depreciation, intensifying inflationary pressure. It is worth noting that both the crowding out international and its hybrid version would only occur with the consent of the Central Bank.
If the Central Bank uses international reserves and the instruments at its disposal strategically, exchange rate depreciation could be avoided, and its negative effects on inflation and the economy would not materialize.
In short, the current scenario in Brazil can be described as a situation of “monetary dominance”. By “monetary dominance” we mean a situation of inconsistency between monetary policy and the dynamics of economic growth. In this context, monetary policy seeks to override economic growth, being pressured by internal tensions and hegemonic conventions of the management of Brazilian private wealth.
The external situation, with the uncertainties surrounding the policies of the new US government, is putting additional pressure on peripheral economies. In addition, portfolio restructuring and the remittance of earnings abroad are impacting the exchange rate, a phenomenon that is particularly significant in Brazil. This movement appears to be more related to the proposal to increase taxation on the wealthiest than to immediate fiscal risks.
Conventions among elite financial wealth managers, the so-called “market,” combined with these factors, structure a monocausal narrative of imminent fiscal risk. This creates a cycle of rising interest rates, nominal deficits, and exchange rate depreciation, in which there are opportunities for speculative gain. Monetary policy, therefore, seeks to block economic growth in order to meet these conventions, which ultimately “explain” the scenario of exchange rate depreciation.
The Central Bank and monetary policy are neither neutral nor independent of the pressures, conceptions and discourses that emanate from the “market”, and which are reflected in the position of the corporate media. The current inflation target is incompatible with the country’s economic reality, and results in monetary policy movements that tend to accentuate instability. The objective of this scenario of “monetary dominance” is to contract economic growth and promote a socially asymmetric fiscal adjustment, in which the poorest are penalized, while the richest sectors maintain their financial wealth.
In the current situation, the scenario for 2025 will be one of lower growth and higher inflation. The inauguration of the new US government and greater clarity on the policies to be adopted could reduce the current tension. It will be important to quickly vote on the tax reform proposed by Minister Fernando Haddad, in order to define its impacts on Brazilian wealth holders.
Still, there is little room for changes in monetary policy in the short term, even with the new president of the Central Bank. The current scenario of “monetary dominance,” created in recent years under the auspices of the Brazilian plutocracy, with a view to protecting its interests, is difficult to dismantle under the current political and economic conditions. The government and the new president of the Central Bank will continue to be subject to a lot of pressure in the coming months.
*Henrique Morrone is a professor of economics at the Federal University of Rio Grande do Sul (UFRGS).
*Alessandro Miebach is a professor of economics at the Federal University of Rio Grande do Sul (UFRGS).
*Adalmir Marquetti is a professor of economics at PUC-RS.
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