Gustavo Loyola says that with the war, the central bank faces a bigger dilemma

The central bank already has a difficult task this week, which is to determine the exact interest dose to fight inflation. But after that, it still has to deal with controversial government decisions affecting the economy. One of them is the possibility of freezing or supporting the price fuel. The assessment was carried out by the CEO of Tendências Consultoria, Gustavo Loyola, who led the Central Bank in two terms – from 1992 to 1993 and from 1995 to 1997.

“I’m against subsidizing or fixing fuel prices,” Loyola says. “It’s like taking from the poor to give it to the rich. The government is spending on the rich to drive.” This week’s meeting of the Economic Policy Committee (COBOM) is considered one of the most challenging for the current administration led by Roberto Campos Neto because of the new and growing suspicions that have arisen from the conflict initiated by Russia’s invasion of Ukraine, he said.

According to Loyola, the central bank will have to decide whether to accelerate interest rate hikes, to respond to a new shock of increases in oil and food prices, which are originating outside Brazil; or if the upward tempo of Selic In the midst of the Brazilian economy is still under pressure from high unemployment and low income.

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This is Copom’s first meeting since Russia invaded Ukraine. conflict already Oil price hike and two foods In international markets a new wave of global inflation.

From March of last year until now, Selic rose from 2% to 10.75%. But inflation measured by the IPCA (National Broad Consumer Price Index), an indicator the government uses as official inflation, also continues to advance, at 6.1%. to 10.5% accumulated in 12 months.

The central bank already has a dilemma. If you expect too much, higher interest rates before inflation, you risk making society pay a heavy price due to the effects on the economy, which becomes weaker. But if the central bank chooses to wait, it may default to inflation, then run to make up for lost time by raising interest rates stronger than it could have been.
Gustavo Loyola, Trends Consulting

See below for a highlight of the conversation.

UOL: Does it make sense for the central bank to maintain the pace of interest rate hikes after the war, even as food and fuel prices rise here in Brazil due to increases in oil and commodity prices abroad?

Gustavo Loyola: The central bank already has a dilemma. If he expects too much, and raises interest rates more before inflation, he risks making society pay a heavy price for the effects on the economy, which is weaker. But if the central bank chooses to wait, it may default to inflation, and then run to make up for lost time by raising interest rates stronger than might be necessary.

The truth is that there are now more doubts. War brings more uncertainty. It can even generate a strong price shock as it did before, in the seventies or nineties.

But it is still too early for British Columbia to change its pre-war plans. For now, following the current policy means the risk of making a mistake is lower.

What the central bank can do to maintain the pace of interest rate increases that it was planning is to be tougher and darker in the market official statement after the decision.

But even with interest rates rising since last year, will inflation keep rising? Is it worth raising interest rates against this kind of inflation?

Makes sense, with due consideration. It is important to remember that Brazilian inflation still has a strong sluggish character [quando contratos são reajustados simplesmente pela inflação passada sem outra razão para aumentar aquele preço; é também chamada memória inflacionária]. So if the central bank allows inflation to spread, there will be a much higher cost of bringing it back.

As many side effects exist, the consequences could be worse. The central bank had already raised interest rates, as part of a plan.

The central bank has no alternative but to raise interest rates. There is a pocket rule in economics which states that in order to reduce demand you have to increase real interest rates. In the case of rising inflation, the fixed rate must at least return to the level it was at before the rise in inflation to prevent real interest rates from falling.

But if inflation came from abroad, what are the reasons for continuing to raise interest rates?

Exchange is one of them. Short-term monetary policy operates through the exchange channel. One of the reasons the dollar acted even after the start of the war was the high interest rate here. Can you imagine what would happen in the Brazilian economy if the dollar now approaches 6 Brazilian reals?

So, maintaining good disposition in dollars is essential to mitigate the effects of increases in commodity and fertilizer prices.

We are still facing demand pressures. Covid has reduced both supply and demand. And demand comes back faster than supply. This is why containers are lost, for example. It is therefore necessary to curb demand so that supply can be adjusted over time.

Wouldn’t the central bank have other tools to control inflation?

no. From the central bank, that would be: raising interest rates. Even on the part of the government, the tools are limited. But there are some tools the government can adopt, such as looking for ways to ensure that inputs, such as fertilizers, are available to reduce the pressures of price increases.

There are discussions about subsidizing or freezing fuel price increases at Petrobras refineries to avoid this Edits like the ones we made this month. Would it be a good alternative to contain inflation?

I am against subsidizing or fixing fuel prices. It is like taking from the poor to give to the rich. The government spends on the rich to ride a car. The grant money has to come from somewhere. If it was from the federal budget, the taxpayers, all Brazilians, would foot the bill.

In addition to Petrobras There has already been a lag in the rates applied here in relation to oil prices in the international market. So, if you stop making adjustments, when you do, there’s going to be a hit, as it has now.

At most, a more convenient alternative would be to slightly lengthen the adjustment conditions to reduce volatility, but without stopping to do so.

Wouldn’t it be the case for re-discussing inflation targets at the moment?

I think the costs of changing inflation targets now will be greater than the benefits. It is true that there can be benefits, for example, in economic activity, where the central bank is more flexible without putting pressure on the economy too much now, warning that this will be a temporary thing and that, later on, it will lower inflation targets again.

The problem is that the signal sent will be bad, because the market may understand that every time inflation starts to rise, the central bank will change its inflation targets. This will affect the credibility of the central bank, which will be more difficult to regain control of inflation.

This year’s inflation target is set in the 2% to 5% range. And for next year, it’s in a range of 1.75% to 4.75%. In 2021, inflation as measured by the IPCA was 10.06%, above the target, which was in a range between 2.25% and 5.25%. An open letter to the communityClarifying the reason for its failure to reach the goals and providing measures to ensure the return of inflation to the established limits, including the period in which these measures are expected to take effect.