GDP is Decelerating, but the Labor Market Indicates a Narrow or Positive Gap

BRAZIL ECONOMICS - Report 05 Dec 2022 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

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The GDP result for the third quarter confirmed what was suggested by other indicators: the deceleration of growth is under way. After a brief analysis of the contributions of the forces acting on the supply and demand sides, and the signs sent by other indicators, we focus here on the evidence from the job market, and especially on the real dimension of the GDP gap. Since potential GDP is an unobservable variable, while actual GDP can be estimated with precision, it is not possible to have full confidence in the empirical measure of the size of the gap. However, even though they have different adjustment dynamics, their fluctuations cannot run contrary to the direction of the unemployment rate.

Based on data from the Continuous PNAD survey, whose series dates to 2012, here we show that the variations of the GDP gap measured by the Central Bank historically closely follow the variations of the unemployment rate. Nevertheless, while at the end of 2021 the GDP gap measured by the Central Bank had started to narrow, and during most of 2022 it widened (lower actual GDP in relation to its potential level), the unemployment rate has continued to decline, without any signs of reversion. Instead of relying on econometrics, here we consider economic history to develop the arguments indicated in the box below, showing that in 2012, the GDP gap was positive while the unemployment rate measured by the Continuous PNAD was around 7.5%. During the pandemic, the jobless rate peaked at 14.9% (21.9% when measured based on the historical average participation rate), and then started recovering in 2021, having returned now to about 8%, with the participation rate returning to its historical average.

With all due precaution about the effects of the Labor Law Reform on the dynamics of the job market, when using this metric the inescapable conclusion is that unlike indicated by the Central Bank’s calculation, the true GDP gap is now very narrow, or even positive, and the economy is close to full employment. If this argument is correct, we have to conclude that for inflation to converge to the target, the interest rate will have to remain at its current high level for longer than otherwise thought, with more intense deceleration of economic activity in 2023.