COPOM, Neutral Interest Rate and Potential GDP

BRAZIL ECONOMICS - Report 25 Sep 2023 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

In the statement issued after the last COPOM meeting, the Central Bank pledged to maintain cuts of 50 basis points per meeting until the end of the year, with the SELIC rate reaching 11.75%. It also warned of the effects of the increase of the neutral interest rate in the United States on Brazil’s neutral rate, and expressed concern over the better than expected economic activity.

Finally, it again mentioned the importance of the “fiscal anchor” in determining the interest rate. The expansionary fiscal policy raises the neutral interest rate, and contrary to the hypothesis mooted by the Central Bank’s president, Campos Neto, that stronger than expected growth is a consequence of better potential GDP, there is no empirical evidence of improved productivity.

Therefore, the reason for the resilience of economic activity is expansion of aggregate demand, which has been spurred by the expansionary fiscal policy despite the restrictive monetary policy. To avoid aggravating the existing unanchoring of expectations, the COPOM alerted to the need to meet the established fiscal targets. In light of all these factors, the SELIC rate should fall to 10.5% at the end of the cutbacks.

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