Upside down

BRAZIL ECONOMICS - Report 20 Dec 2024 by Alexandre Schwartsman, Cristina Pinotti and Diego Brandao

In recent weeks, suspicions that we are operating under a fiscal dominance regime, or very close to it, have surfaced. However, we still do not believe this to be the case, despite monetary policy weakening in face of fiscal policy mismanagement, which has rapidly increased the costs of disinflation.

We reckon it is more likely that a milder version of fiscal dominance will emerge, where the Central Bank sets a more moderate interest rate path, inconsistent with meeting the inflation target. Thus, the Central Bank establishes a more favorable debt trajectory in exchange for persistently higher inflation. This reverses the logic of economic policy: instead of controlling debt to keep inflation on target, high inflation becomes the "solution" to debt mismanagement.

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