By FERNANDO NOGUEIRA DA COSTA*
When inflation is caused by a supply shortfall, such as raw material shortages or production interruptions, monetary policy is not effective.
Inflation is typically a macrosystemic phenomenon. It emerges from alterations in the relative price system being reflected in the change in the weighted average value of prices of a basic basket of goods and services, compared to the previous month.
To get an idea of its complexity, every month, the IBGE surveys 15 cities, monitoring 430 prices, in 30 locations, for a basket of 377 goods and services. The influences of these metropolises are weighted by the participation of the average income of their families, for example, São Paulo represents 32,3% and in second place is Belo Horizonte with 9,7%, surpassing Rio de Janeiro with 9,4% .
The analytical challenge, then, is to scrutinize the mechanisms of systemic transmission. Economics uses (and abuses) metaphors from other areas of knowledge, in this case, the mechanics of physics and/or automotive engineering.
Economists need to start from holism rather than methodological individualism. This focuses only on the decisions of individuals, considered as being homogeneous.
It theorizes the iteration (repetition) of the same microeconomic decisions, but they involve interactions (deals and price fixing contracts) with the decisions of others. The specific knowledge of economists is precisely the analysis of macroeconomic results in dynamic configurations, that is, variables over time.
The first deduction is that the context is always changing, therefore, the iteration of decisions occurs in different scenarios and, hence, has unexpected or uncertain results. After all, decisions are decentralized, uncoordinated and uninformed about each other interactive – many have not even been taken yet…
The world context has changed in the last four years. There was a deflationary trend for about 30 years, due to the immense shock with the increase in the supply of labor, on a world scale, by the entry of China, India, other Asian countries and Eastern Europe into the new international division of labor with globalization and the external opening of national economies to world trade.
In addition to this greater offer of workforce, the entry of “baby-boomers” (the highest post-war birth rate) and, in particular, well-prepared women in the labor market. The dependency rate decreased, that is, the ratio of the working-age population to the non-working-age population increased.
With all this, there was a decrease in union bargaining power, whose workers had their unions decimated by the neoliberal labor reforms. The consequent lower CUT (Unitary Labor Cost) caused greater social inequality and resentment anti-establishment of neo-fascists with arms, evangelicals and rednecks from the countryside.
The great financial crisis (GCF) of 2008 led to monetary easing, interest rates falling to negative real levels, asset inflation with capital flight from fixed income to variable income – and consequent concentration of wealth. Many rural people with a loss of social status felt inferior in relation to the intellectual elites of the east and west coasts in the USA – and east in Brazil.
Now, with the great demographic reversal, the global context in the long term changes from a deflationary to an inflationary bias. There is a lower birth rate, greater longevity, an increase in the number of retirees and dementia in the elderly, requiring an increase in the tax and social security burden to meet the demand for public health.
The smaller workforce becomes responsible for non-productive dependents (few children and many parents and grandparents). Personal resources to meet this demand will depend on an increase in union and CUT bargaining power, with the expected reaction in raising the capital / labor ratio to increase productivity.
Faced with this scenario of a new world, he was faced with the pandemic (2020-22). The economic consequence was, in the first year of pandemonium, supply shortages with ruptures in production and commercial chains, caused by social distancing.
In addition, the weather phenomenon El Niño brought more extreme temperature rises, worsened drought conditions, and commodities. The war in Ukraine further increased the prices of food, fuel and fertilizers.
These adverse supply shocks affect countries asymmetrically, implying different dynamics for core inflation and for inflation expectations. There is divergence in monetary policy responses and exchange rate movements.
The automatic (and widespread) reaction of Central Banks to the drop in global supply made the situation worse by imposing an abusive social burden. They adopted a mistaken recessive monetary policy to control aggregate demand.
The current facts demonstrate the mistake of the monetary authorities. According to World Economic Outlook Update July 2023, published by the IMF, global nominal inflation is expected to decline from an annual average of 8,7% in 2022 to 6,8% in 2023 and 5,2% in 2024, but still above pre-pandemic levels (2017–19) of around 3,5%.
About ¾ of the world's economies are expected to have lower average annual inflation in 2023. The tightening of monetary policy would gradually reduce inflation, via recession, but a central factor in the disinflation projected for 2023 is the drop in international prices of commodities.
Differences in the pace of disinflation across countries reflect factors such as different exposures to movements in commodity prices. commodities and currencies and different degrees of post-pandemic economic warming. “Tight” labor markets and the pass-through of past exchange rate depreciation undermine long-term inflation expectations in several, but not all, economies. The institutional configuration of wage setting in some countries leads to the replacement of inflationary losses on wages.
According to the IPEA Conjuncture Letter (2nd quarter of 2023), the scenario for this year is one of disinflation. In addition to the normalization of global supply chains, the dissipation of the initial effects caused by the war in Ukraine and the favorable winter weather in the northern hemisphere, the effects of the monetary tightening by the Federal Reserve (FED) caused a drop in the quotations of risky assets, including the prices of commodities.
In Brazil, the process of appreciation of the real against the dollar adds to the drop in international commodities, intensifying the deflationary force of this cost component. The maximum value of the currency quotation, since the beginning of the year, occurred on January 4, reaching R$ 5,45/US$; the minimum value was R$4,77/US$, on June 26th. Since June 2, the real has been quoted below R$5,00/US$.
Risk premium indicators for peripheral countries, influenced by changes in international liquidity, improved, leading to more IDP (Direct Investment in the Country). Allied to this factor, favorable trade flows also act towards a greater supply of dollars in the economy. The disparity between internal and external interest rates attracts domestic financial assets and long positions in the Brazilian currency.
The historical pattern was one of inverse correlation between the movement of quotations in dollars of commodities and the real/dollar exchange rate. In the period 2020-2021, the exceptionality of the historical moment reversed the previous direction of this correlation, when the rise in prices in dollars and the devaluation of the national currency combined and caused an inflationary wave in the Brazilian economy.
Together they constitute a strong deflationary pressure, initially captured in wholesale prices and producer prices. It tends to be transmitted, with a delay of months, to retail and, therefore, is gradually captured in consumer prices.
Even the prices of services not monitored by the government felt the propagation of this cost shock to other sectors with a delay. They also register a trajectory of disinflation.
Prices monitored by the government still record deflation in the twelve months ending in May 2023, due to tax relief measures adopted for electoral reasons, in the second half of 2022, on fuel and electricity prices. There will be a statistical effect of rising inflation over twelve months, replacing the lower monthly indices of the second half of 2022.
When inflation is caused by a supply shortfall, such as shortages of raw materials or interruptions in production, monetary policy is not effective, as the root of the problem lies in the limited supply of goods and services. It even makes the situation worse by further reducing demand and economic activity without addressing the underlying cause of inflation.
In situations of supply shock, fiscal stimuli to increase production or direct interventions in the affected sector are more appropriate to deal with inflation.
*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Brazil of banks (EDUSP).
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