What Will be the Size of the Easing Cycle?
Various controversies exist in the financial market regarding the execution of monetary policy. One of them refers to the size of the total cut in the interest rate. Another involves the pace of the initial movements by the Central Bank. The past few days have been marked by critiques by those who prefer larger initial cuts, while at the other extreme some observers believe the initial cut of 25 basis points at the last COPOM meeting was overly hasty. Our objective in this report is not to discuss that decision. It was a unanimous decision, with the committee members recognizing that conditions exist to start easing, taking into consideration various risks, such as those from the still-undefined fiscal policy and the excessive inertia of service prices. We concentrate here only on presenting arguments that the pace will very likely increase at the forthcoming COPOM meetings, and that without abandoning convergence to the inflation target of 4.5% the total easing cycle will be large, probably reaching the one-digit level at its end, creating conditions for resumption of growth.
We recognize that the lack of knowledge about the true neutral real interest rate requires the Central Bank to be cautious initially and to react to developments while executing its task. All the same, our estimate is that the cycle will be long and intense, based on: a) the record size of the output gap; b) the signs that the credit channel of transmission of monetary policy to the real economy is temporarily obstructed; c) the latest communiqué from the Central Bank stressing that monetary policy will be implemented in light of the targets for 2017 and 2018, with the latter year gradually gaining weight in the Committee’s decisions, and for which the Bank’s projections are below the target; and d) the perspective for approval of fiscal adjustment measures, along with other reforms with potential to reduce even more the neutral real interest rate.
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