Monetary Policy Challenges In 2023: Global and Brazilian Economies

BRAZIL ECONOMICS - Report 19 Dec 2022 by Affonso Pastore, Cristina Pinotti, Paula Magalhães and Diego Brandao

By causing a succession of supply shocks, the pandemic raised inflation around the world. Indeed, virtually all countries reacted to the economic effects of the health crisis with huge monetary and fiscal stimulus policies, causing high inflation whose control now requires both a return to fiscal discipline and restrictive monetary policy on a global basis.

The inevitable consequence will be deceleration of economic growth in 2023, affecting both advanced and emerging countries. In Brazil, the Central Bank indicated its shift to a restrictive monetary policy before the monetary authorities of other emerging countries, but also has to face the effects of fiscal impulses in the opposite direction, reflected in an increase of the risk premiums and an upward shift of the yield curve. In a side box in the last Inflation Report, the Central Bank demonstrated, based on the behavior of the interest rate, that the long-term interest rates movements have been almost exclusively due to the variations of the risk premiums associated with the signs from fiscal policy.

Based on a model in which the GDP gap was already negative (disinflationary), it warned that to bring inflation to the target (only in 2024, since according to the Focus survey, at the end of 2023 inflation will still exceed the upper bound of the target interval), the Selic rate will have to remain constant at its current level for an extended period. That Report also reveals that in the Central Bank’s model, the GDP gap is still negative. Unfortunately, the Report did not have an aside explaining in detail how the gap is estimated, but the potential GDP implicit in its estimation indicates that the opening of the gap has largely been due to growth of productivity. In other words, the shift of the GDP gap to negative territory has been caused more by the increase of potential GDP than by a decline of aggregate demand triggered by monetary policy. We have no explanation for this puzzle, but it exists and needs to be clarified.

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