Global Inflation and Slower Growth: Consequences For Brazil

BRAZIL ECONOMICS - Report 10 Jul 2023 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

The pandemic was an unprecedented event that triggered a wave of fiscal and monetary stimulus measures, together leading to an outbreak of inflation around the world. The United States and the Euro Zone, which together account for almost 40% of global GDP, established fiscal stimulus actions that in the USA amounted to 14.7% of GDP in 2020, in 2021 reached 8.1% of GDP and in 2020 and 2021 together reached 8% of GDP in the Eurozone.

Likewise, these countries enacted monetary stimulus measures that not only brought interest rates to their effective lower bound, but also almost doubled the combined assets of the Federal Reserve and ECB. By purchasing sovereign bonds and other assets financed by bank reserves, on which they paid interest, the central banks did not monetize the respective public debts, but instead raised the prices of the assets acquired and reduced the interest rates at the long end of the yield curve, thus accentuating the monetary stimulus.

The consequence of these monetary and fiscal stimuli was sharply higher global inflation. By raising aggregate demand, the fiscal expansion increased the neutral real interest rate (the real risk-free rate at which aggregate demand growth is equal to potential GDP growth). This situation required the Federal Reserve and ECB to increase their respective benchmark interest rates and start reducing their assets by selling public bonds and other financial assets, reducing these instruments’ prices and elevating their yields. In a situation like this, achieving a soft landing seems to be wishful thinking to us. The more likely scenario is a substantial deceleration of global growth.

This is already under way in the Euro Zone, and there is a strong likelihood of a recession in the United States next year. At the end of this report, we analyze the consequences of this picture on the Brazilian economy. The decline of world growth will certainly reduce Brazilian growth. Against a backdrop of greater fiscal discipline, this would open room for a more intense reduction of the SELIC rate. But if the government’s reaction to the slower global and Brazilian growth is to increase spending to stimulate the economy, this space will be smaller and the conditions will be worse for economic recovery.

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