It's politics, stupid

Image: Fabio Rodrigues-Pozzebom / Agência Brasil
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By LUÍS SERGIO CANÁRIO*

Nothing is as good as Central Bank of Brazil don't ruin it

On June 25th, the Central Bank of Brazil released the minutes of the 263rd meeting of the Monetary Policy Committee (COPOM) held on June 18 and 19, 2024 []. At this meeting, following the expectations of the financial market, but contrary to the expectations of Lula and many economic agents outside the financial market, it was decided unanimously, with the votes of the directors appointed by Lula, to maintain the basic interest rate, the SELIC, at 10,5% per year.

This decision had already been announced, as usual, in the COPOM Communiqué of June 19, shortly after the end of the meeting. The minutes detail the reasons for this decision. This text seeks to analyze in a language closer to the language spoken in Brazil than what economists, especially those from the BCB, speak.

Starting with a question. What would society think if, to determine the price of gasoline, the National Petroleum, Natural Gas and Biofuels Agency (ANP) maintained an application on the internet where gas station owners could enter their future fuel price expectations and use this information to establish the price at the pumps? Common sense would say this is absurd. Those directly interested in the subject would obviously give their opinion according to their interests when reporting their “predictions”. And that goes for any merchandise.

But it is a similar process that the Central Bank of Brazil uses to set the price of the most important commodity in the capitalist economy: money. By setting the SELIC, the price of money is fixed. Roughly speaking, setting the rate at 10,5% per year means that to “sell” R$100, or the merchandise, after a year you have to “return” the R$100 and “pay” R$10,50 for having used by that time the money was “sold”.

Seen from another angle, these R$100 must produce something, goods or services, that result in a profit greater than R$10,50. If the rate were 8% per year, R$8 would be needed to pay for usage and, consequently, the profit would need to be at least R$8, R$2,50 less than with the 10,5% rate. This is the effect of the basic interest rate on the economy. Projecting this approach onto the R$8,5 trillion of Brazilian public debt gives a clue about the impact caused by the Central Bank of Brazil on public accounts when setting the SELIC rate.

The Central Bank of Brazil receives forecasts from financial market agents, registered and authorized to do so, and publishes them weekly in the Focus Bulletin with the medians of the informed expectations. There are four pieces of information: IPCA, GDP, exchange rate, and SELIC. These are forecasts for the current year and the following three years. More detailed information can be found here.

The Minutes explicitly state: “In the reference scenario, the path for the interest rate is taken from the Focus survey”. The monetary authority uses the “forecasts” of market agents as a reference for its decisions. It does not use it as additional information in its “technical analyses”, it uses it as a reference. The dispersion of these “forecasts”, released on 01/07/2024, is curious: the “market” quickly converges towards the rate that the Central Bank of Brazil sets. A month before the division was greater and two months before it was “anchored” at the 9,25% to 10% level, with many people in the 8,5% to 9,25% range. “Guilt” for Lula’s speeches?

The Minutes are structured into four parts: (i) Update on the situation and scenario, (ii) Scenarios and risk analysis, (iii) Discussion on the conduct of monetary policy and (iv) Monetary policy decision. It is written to be read by those literate in the hermetic language of economic agents. Despite being a public document from a public agent, the distinguished public, the country's citizens, do not understand much. Who can understand terms like “output gap” or “neutral real interest rate”? Is this language a strategy to avoid being understood? But shouldn't it be possible to be read by anyone? More about this possible “strategy” can be seen here.

The Minutes begin with two good news: “In relation to the domestic scenario, the set of economic activity and labor market indicators has shown greater dynamism” and “Consumer inflation has shown a disinflation trajectory”. The job market and economic activity are doing well and inflation is falling. But, always he, for the first news there is the complement “than expected.”. And secondly, “while measures of underlying inflation were above the inflation target in the most recent releases.”

Nothing is so good that the Central Bank of Brazil doesn't ruin it. One news is bad because it is above previous gloomy forecasts and the other because the variation in some prices, such as food, is above full inflation. The Focus of 28/06/2024, therefore after the release of the Minutes, points to inflation of 4% in 2024, 3,87% in 2025, 3,6% in 2026 and 3,5% in 2027. In the Minutes the COPOM projects 4% in 2024 and 3,4% in 2025. The government projects 3,5% in 2024 and 3,1% in 2025.

But, here it comes again, there is an important fact: “the Committee analyzed and communicated an alternative scenario with the maintenance of constant interest rates, with a trajectory anticipated by agents, over the relevant horizon. In such a scenario, projections for inflation stand at 4,0% and 3,1% for 2024 and 2025, respectively.” Despite denying it, it remains clear that keeping interest rates constant “over the relevant horizon” lowers 2025 inflation to the value predicted by the government. Coincidence or a warning to the government that for its forecast to materialize it needs to accept the SELIC at this level in the “relevant horizon”. And how far does this “horizon” go, one year?

Some positive data and information from the Minutes: (a) “The price of oil approximately follows the future curve for the next six months and starts to increase 2% per year thereafter”; (b) “the hypothesis of a “green” tariff flag in December 2024 and 2025 is adopted”; (c) “The Committee reiterated that there is no mechanical relationship between the conduct of US monetary policy and the determination of the basic interest rate”.

(d) “Over the last few quarters, economic activity data has surprised, with greater growth in different components of demand. The resilience of domestic activity and the sustainability of consumption over time were highlighted, in contrast to the scenario of gradual deceleration originally anticipated by the Committee”; (e) “new bullish surprises were observed in the activity. Such surprises were concentrated in gross fixed capital formation and family consumption, supported primarily by the labor market, social benefits and court-ordered payments.”

(f) “The output gap, which was slightly negative in the last published assessment, … is now around neutrality”; (g) “marginally raised the neutral real interest rate assumption in its models to 4,75%. … the Committee evaluated scenarios with a neutral rate between 4,5% and 5%; (h) “The Committee assessed that data regarding inflation suggest a trajectory that did not differ significantly from what was expected”; (i) “The majority of the Committee decided to maintain the balance of risks symmetrical at this meeting”.

For those uninitiated in this strange Ata language, the output gap is the difference between real GDP and the GDP that analyzes indicate it could be. If it is positive, it indicates an overheated economy with a GDP higher than it should be, according to these analyses. If negative, it indicates that the economy is operating below its potential and has room to grow. The difficulty is estimating potential GDP. There are methodologies for this, but none have the precision to assess the future. On the website of Interinvest [https://interinvest.inter.co/] is the graph below with the variation from 1998 to 2022. This indicator spent more time in the negative over these years.

Another indicator that can be better explained is the neutral interest rate. It is the interest rate that neither accelerates nor decelerates inflation. Again, it is not an indicator that can be observed or measured. It is an estimate that takes into account many other indicators. In popular language, a kick with some discretion. With inflation approaching 4% and the BCB's neutral rate being 4,75%, the neutral interest rate would be 8,75%, for a SELIC of 10,5%.

It is important to highlight that when he talks about a symmetrical balance of risks he is talking about the high inflationary risk being the same as the low inflationary risk in the BCB scenarios. This decision was taken by a majority and not unanimously. There were disagreements, which are not clearly explained in the Minutes, nor does it say who defended what.

The Minutes also criticize the government's economic policy. Some even in a threatening tone. But with so many apparently positive elements, what are the reasons for not continuing to reduce the SELIC? From the Minutes: “a scenario of greater global uncertainty suggests greater caution in the conduct of domestic monetary policy”; “there is great uncertainty regarding the economic effects of the tragedy in Rio Grande do Sul”; “the slowdown in the effort towards structural reforms and fiscal discipline, the increase in targeted credit and uncertainties about the stabilization of public debt have the potential to raise the neutral interest rate”; “The Committee unanimously assesses that the re-anchoring of inflation expectations should be pursued regardless of the sources behind the de-anchoring now observed”; “Among the upside risks to the inflationary scenario and inflation expectations, they stand out.”

Faced with this scenario, the Central Bank of Brazil unanimously decided: “Considering the evolution of the disinflation process, the scenarios evaluated, the balance of risks and the wide range of information available, the Copom decided to maintain the basic interest rate at 10,50, 2025% pa and understands that this decision is compatible with the strategy of inflation convergence around the target over the relevant horizon, which includes the year XNUMX. Without prejudice to its fundamental objective of ensuring price stability, this decision it also implies smoothing fluctuations in the level of economic activity and promoting full employment”.

And it continues: “The current situation… demands serenity and moderation in the conduct of monetary policy”. “The Committee unanimously opted to interrupt the cycle of falling interest rates, highlighting that the uncertain global scenario and the domestic scenario marked by resilience in activity, rising inflation projections and unanchored expectations demand greater caution.”

Despite talking about a neutral risk balance, the Central Bank of Brazil decides to tip the balance to one side and reduce the effect of the positive aspects. Why that? To paraphrase a famous phrase from Bill Clinton's 1992 presidential campaign: It's politics, stupid! With the approval of the directors of the Central Bank of Brazil appointed by President Lula.

*Luis Sergio Canario is a master's student in political economy at UFABC.


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