The GDP “Surprise” and Monetary Policy

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

Contrary to the nearly unanimous expectation of a decline between 0.2% and 0.3%, GDP in the third quarter expanded by 0.1%, largely thanks to the robust performance of household consumption. Although that growth was also benefited by the strong increase of exports, its main cause was growth of consumption, fed by the expansionary fiscal policy, including income transfers, and a tight labor market, responsible for a steady increase of real labor income.

The expansionary fiscal policy has for a long time been acting contrary to the restrictive monetary policy, and this is one of the reasons for the unanchoring of expectations, revealed both by the Focus survey and the implicit inflation indicated in the real and nominal yield curves. The Central Bank’s forward guidance in the minutes of the last COPOM meeting clearly stated that “in upcoming meetings” (read “in the next two meetings”), the SELIC rate will be cut by 0.5 percentage point.

Thus, the SELIC rate at the end of 2023 will be 11.75%, and it will decline to 11.25% at the January meeting. Until then, the analysis will be on solid ground. But what will the new forward guidance be? The good behavior of inflation (both the headline measure and the core rates), along with some improvement in the external scenario, open the possibility it will be maintained. However, the effects of the expansionary fiscal policy and unanchoring of expectations will work in the opposite direction (mainly on growth of household consumption).

If the Central Bank’s goal is to meet the central target, it should alter the current forward guidance, opening the way to a reduction of the easing pace as of the second COPOM meeting next year. But if it will be satisfied with inflation below the upper bound of the interval containing the target, and worried about handling the noise generated by the government’s pressure on its decisions, it can hew to the current forward guidance. The text of the communiqué and minutes of the next meeting will reveal the weight given by the Central Bank to achieving the central target, and its concern over the government’s reactions.

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