Fernando Haddad, the tightrope walker

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By MAURO PATRÃO*

Lula's Finance Minister has been seeking to increase the tax burden in the short term without increasing taxes, reducing socially unjustified public spending

The macroeconomic explanation that supports the attention given by minister Fernando Haddad to the deficit and the financing of public spending is, basically, the macroeconomic explanation of the mainstream (set of schools of orthodox economic thought) in the USA and other so-called developed countries. The approach of Brazil's finance minister, Fernando Haddad, is largely similar to that of US treasury secretary Janet Yellen, who was also the country's first female president. Federal Reserve, the powerful US Central Bank – and in these matters, attention should not be paid to what developed countries advise, but rather to what they practice.

After the 2008 crisis and especially after the pandemic, several economists declared the intellectual bankruptcy of the conventional view of mainstream. Here in Brazil, one of the best-known representatives of this group is André Lara Resende, who, in January 2017,[1] started to defend the so-called fiscal theory of the price level, even citing one of the main representatives of the Chicago school (Fresh Water Economics), John Cochrane. By the way, Lara Resende, more recently, started to defend the so-called modern monetary theory (MMT). Both views are in the minority in the macroeconomic debate in the USA and developed countries.

The truth is that Lara Resende and other economists only had to pay attention to the right people to realize that the conventional view of mainstream economy in the USA explained in a fully satisfactory way and in advance what ended up happening to the economy, both after the 2008 financial crisis and after the pandemic.

To verify this statement, just read a few articles from January 2009,[2] [3] [4] of the Nobel prize winner in economics, Paul Krugman, precisely criticizing John Cochrane and defending a more aggressive fiscal policy by the Barack Obama government, in addition to using conventional Keynesian theory to show that there would be no increase in future interest rates, despite the increase in the deficit, nor would there be hyperinflation, despite the gigantic increase in the monetary base (Quantitative Easing), as in fact it did not happen.

It would also be enough to watch the debate between Krugman and Larry Summers in February 2021,[5] in which the first correctly argued that post-pandemic inflation was transitory (Team Transient). Or read the February 2021 article[6] No. Peterson Institute (the same as Olivier Blanchard) stating that the comparison of what was happening post-pandemic should not be with the 1970s and the Vietnam war, but with the 1950s and the Korean war.

Let's see how Fernando Haddad fits into this theoretical circuit.

Fiscal and monetary

Minister Fernando Haddad states that fiscal and monetary policies are like two arms of the same organism. In his view, both serve to regulate aggregate demand (domestic demand and the country's exports) and both have distributional impacts.

Controlling aggregate demand, in turn, is fundamental to controlling inflation and unemployment. If aggregate demand grows more than aggregate supply (the country's domestic supply and imports), the result is an increase in inflation. When unemployment is high and much equipment is idle, it is easier to increase aggregate supply so that it keeps up with an eventual increase in aggregate demand, without increasing inflation.

As unemployment and idleness decrease, this process becomes more difficult and the growth rate of aggregate supply begins to be limited by the growth rate of the population of working age plus the growth rate of the average productivity of workers.

On the other hand, if aggregate demand grows less than the population of working age combined with the average productivity of workers, the result is an increase in unemployment. Fiscal and monetary policies must, therefore, control the growth of aggregate demand in order to obtain stable inflation with as little unemployment as possible.

Never lack money?

The statement made by several so-called progressive economists that there is never “a lack of money” for public spending is also correct. So much so that in 2020, after four years of constant and emphatic statements that the government was broken, as if by magic, the largest amount of money in Brazilian history “appeared” (R$638 billion in current values ​​just in 2020) to combat the effects of the pandemic.

In moments like this, as well as after the 2008 financial crisis, it was and is essential to sustain aggregate demand through the deficit, regardless of its size. But it does not follow that the government should spend without worrying about the deficit or surplus. To understand this, you need to understand how fiscal and monetary policies work.

Fiscal policy increases aggregate demand when public spending grows more than taxation, as the increase in public demand outweighs the eventual decrease in private demand. Monetary policy increases aggregate demand when the interest rate determined by the Central Bank (the SELIC rate) decreases relative to the expected future inflation rate, as Brazilian government bonds become less attractive. Part of the agents prefer to spend or invest in the real economy (especially in construction), which increases domestic demand, while another part of the agents prefers to invest in bonds from other governments (especially the US).

This increases the demand for dollars in relation to the demand for reais, which decreases the value of the real in dollars, making Brazilian products cheaper in dollars, so that exports grow more than imports.

It is important to note that fiscal policy and monetary policy can go in the same direction, reinforcing their effects, or in opposite directions, attenuating and even canceling the effect of the other. For example, fiscal policy can reduce aggregate demand, while monetary policy increases aggregate demand by reducing interest rates. And this is exactly what Fernando Haddad is looking for at this moment – ​​of course, always depending on the collaboration of the Central Bank.

The cat's leap

Why is this process important? Firstly, due to the distributive aspect, since financial assets that are remunerated by interest are in the hands of the top of the income or wealth distribution. Second, because a lower interest rate makes many long-term projects that are essential for faster growth in the economy's productivity, such as certain infrastructure projects, as well as research and innovation projects viable, which, in turn, increases the growth rate sustainable per capita income.

Third, because higher interest rates than those in other countries value the real in relation to the dollar, making Brazilian industry uncompetitive internally and externally.

It is also important to note that fiscal policy can reduce aggregate demand by reducing, maintaining or even increasing public spending as a proportion of GDP. All it takes is for taxation to grow more than public spending.

The size of public spending as a proportion of GDP and also its quality are eminently political decisions, part of the distributive conflict. In this context, Minister Fernando Haddad's fiscal framework proposal and especially the proposal that was effectively approved in Congress guarantee that the growth in public spending is lower than the growth in taxation.

This implies that, if the tax burden as a proportion of GDP remains constant, the size of public expenditure as a proportion of GDP will decrease, that is, there will necessarily be a reduction in the size of the State in relation to GDP.

The zero deficit

On the other hand, Fernando Haddad has been seeking to increase the tax burden in the short term without increasing taxes, reducing socially unjustified public spending, such as various exemptions that no longer have or never had a reason to exist.

Therefore, it does not make much sense, from the point of view of the most progressive sectors, to criticize Fernando Haddad's quest for zero deficit, since, at the moment, this quest is being carried out with the aim of taxing part of the very rich who have been paying little or, in some cases, almost no taxes.

The necessary criticism of reducing the size of public spending must be directed at the correct target, the current fiscal framework, which, despite being considerably better than the infamous spending cap approved by Michel Temer and maintained by Jair Bolsonaro, presents some structural problems , especially in the medium term, and will necessarily have to be improved.

To the sadness of those who criticize Fernando Haddad day in and day out – and despite the known precariousness/lag of the economic debate in Brazil, Lula's Minister of Finance is well followed in the theory and practice of conducting macroeconomics.

*Mauro Patron He has a PhD in economics from UnB and is a professor in the Department of Mathematics at UnB..

Notes


[1] Lara Resende, A.: Interest and intellectual conservatism: https://valor.globo.com/eu-e/coluna/juros-e-conservadorismo-intelectual.ghtml

[2] Krugman, P.: A Dark Age of macroeconomics (wonkish):

https://archive.nytimes.com/krugman.blogs.nytimes.com/2009/01/27/a-dark-age-of- macroeconomics-wonkish/

[3] Krugman, P.: Liquidity preference, loanable funds, and Niall Ferguson (wonkish):

https://archive.nytimes.com/krugman.blogs.nytimes.com/2009/05/02/liquidity-preference-loanable- funds-and-niall-ferguson-wonkish/

[4] Krugman, P.: How Did Economists Get It So Wrong?: https://www.nytimes.com/2009/09/06/magazine/06Economic-t.html

[5] A Conversation with Lawrence H. Summers and Paul Krugman: https://www.youtube.com/watch?v=EbZ3_LZxs54

[6] Gagnon, JE: Inflation fears and the Biden stimulus: Look at the Korean War, not Vietnam:

https://www.piie.com/blogs/realtime-economic-issues-watch/inflation-fears-and-biden-stimulus- look-korean-war-not-vietnam


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