Populism, Inflation Target and Expectations
With high inflation and clear evidence of slowing growth – which is nothing more than the cost paid to reduce inflation – President Lula has opened a campaign to increase the inflation target. With a discourse typical of a left-wing populist, he is accusing the Central Bank of protecting the elite “rent-seekers” in detriment to workers, whose jobs are threatened by the deceleration of growth provoked by an interest rate of 13.75% per year that “has no justification”.
His true objective is not to raise the inflation target, but instead to force the Central Bank to lower the interest rate, which is high due to the combination of high inflation and a fiscal expansion that has grown worse since the start of 2022. It is the job of the ministers who compose the economic team to explain to the president that in the inflation targeting regime, the target should attract expectations, but this only happens if the Central Bank has the credibility that comes with full independence in the use of its instrument, which is the interest rate.
The absence of signs that anyone is working to find a cease-fire in this war where everybody is losing worsens the outlook for economic performance in 2023. We start this report by showing the consequences of this war on the yield curve and the debt dynamics, and then analyze its consequences on inflation and economic activity. The upshot will be to keep the interest rate high for longer and aggravate the debt dynamics.
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