Fiscal Expansion and Its Consequences on Monetary Policy

BRAZIL ECONOMICS - Forecast 11 Sep 2023 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

With the approval of the fiscal framework, the government will guarantee an increase in spending in real terms of 2.5% in 2024, and in an interval between 0.6% and 2.5% in 2025 and 2026. At the same time, primary result targets have been established of zero in 2024 and surpluses of 0.5% and 1.0% of GDP in 2025 and 2026, respectively. Those primary results are supposed to be achieved by closing fiscal evasion loopholes and eliminating privileges to boost revenues.

In our evaluation, however, there is no way to obtain the necessary revenues without increasing the rates of existing taxes. Hence, there should be primary deficits in 2024, 2025 and 2026, so that by elevating the neutral interest rate, the expansionary fiscal policy will reduce the effect on aggregate demand coming from the restrictive monetary policy. Economic growth will thus be relatively greater, but the increase of government consumption will occur by crowding out demand from the private sector. That result will depend on the Central Bank’s achieving its mandate of leading inflation to the central target in 2025.

Led by growth of household and government consumption, GDP growth should reach 3.2% in 2023 and 1.5% in 2024. With the SELIC rate at 11.75% at the end of 2023, and finishing the easing cycle at 10.5% in 2024, inflation should amount to 5% at the close of 2023, and 4% at the end of 2024. The risk, however, is that the Central Bank will start working with an implicit target above the central target. In this case, inflation will be higher, with unanchored expectations.

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