The Meaning of Restrictive Monetary Policy

BRAZIL ECONOMICS - Report 16 Aug 2021 by Affonso Pastore, Cristina Pinotti and Paula Magalhães

In making the decision to raise the SELIC rate above the level compatible with the neutral level, the Central Bank announced it will execute restrictive monetary policy. Without counting on the “expectations channel”, which is becoming unanchored, and without a contribution from the “exchange rate channel”, where the hope for appreciation is fading due to the muddled political and fiscal picture, the Bank was obliged to activate the “aggregate demand channel”, meaning widening the (negative) GDP gap.

Since the lags of monetary policy are long, and since the contractionary level necessary to put the market real interest rate above neutral will only be reached several months in the future, the most important consequences for economic growth will only be felt in 2022. When reporting their projections for growth in 2022 via the Focus survey, analysts will have to abandon the “automatic pilot” of repeating the “consensus” that growth will be equal to the potential level of 2%, and instead report a projection lower than that. It should be recalled that in 2022, Brazil will not have the same support for growth as in 2021, given by strong expansion of world trade and rising commodity prices.

With narrow fiscal room during an election year, a risk of pressure from the exchange rate will exist, hampering the Central Bank’s task even more. The most likely outcome will be that the narrow space to increase spending, perhaps created by passage of the constitutional amendment (PEC) relaxing the payment period of judicial credit warrants (precatórios) will be insufficient to satisfy the political ambitions of Bolsonaro.

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