José Luis Oreiro
Associate Professor of Economics, University of Brasília (Brazil)
“So, the rentiers and the financial sector, which have a very thigh relationship with the Central Bank, are taking advantage of the last few months that remain of their absolute dominance over the Central Bank to make the largest possible income extraction from the rest of the society. … Taking advantage of a government that is falling apart, which has no chance of re-election, to make the most of it, that is, it is pure plunder of the Brazilian economy.”
On Wednesday August 3, the Monetary Policy Committee of the Brazilian Central Bank (COPOM/BCB) raised the short-term interest rate by 50 basis points, from 13.25% to 13.75%. Despite the unemployment rate still above the 2014–2016 pre-crisis level, since March 2021, the Brazilian Central Bank began a very fast and deep process of “normalization” of monetary policy, raising the Selic rate from 2% to 13,75% — the greatest increase in the short-term nominal interest rate in the western world in such a short time-span. In this note, I will discuss the reasons — or rather excuses — the Brazilian Central Bank (BCB hereafter) gives in defending the increases of the selic rate in the last meeting of COPOM.
One of the reasons given by the BCB is the so-called Bolsonaro’s goodness package, also called “PEC Kamikaze” — a 50% increase in income transfers to the poorest Brazilian people in a desperate attempt to increase Bolsonaro’s popularity and win the presidential elections, in October 2022. The BCB warns against the risk of this “populist measure” becoming permanent after the end of 2022. They do not say so explicitly, but the BCB refers to the future government of President Luiz Inácio Lula da Silva. As such, due to the increased fiscal risk this new government would pose, the Central Bank justified another rise of half a percentage point of the Selic rate.
The problem with the successive increases in the short-term interest rate made by the BCB is that it is not clear what is the nature of inflation, according to the analysis of the Central Bank?
In my view, not the BCB´s view, actual inflation in Brazil (and maybe in the western world in general) is a persistent — but not permanent — supply shock problem: you have food and energy inflation resulting from a series of events that are persistent in time, such as the war between Russia and Ukraine, the long-standing effects of COVID-19 on the world supply chains, and so on. These effects are lasting longer than we expected. In fact, no one expected that at the end of 2021 that the war of Russia and Ukraine would take place, which certainly added great inflationary pressure due to the interruption of exports of corn and wheat from both Russia and Ukraine, as well as western sanctions against Russia which affected the international price of oil and gas, increasing global energy and food inflation. That’s my diagnosis.
However, the BCB apparently has two contradictory diagnoses. The first diagnosis is that the rise in inflation in Brazil stems from a deterioration of the fiscal framework that has recently been accentuated by increases in government expenditures that resulted from the so-called ‘PEC Kamikaze’, and that there is a risk that the measures of the ‘PEC Kamikaze’ will become permanent if former President Lula wins the presidential run in October. That is, in the next government, they will be maintained, which would increase the public debt and inflation.
Well, there’s no direct causal relationship between public debt and inflation. That’s an unbelievable primitive economic thinking. I mean, if it were because of that, Japan should have the highest inflation rate in the world, because Japan has a government debt-to-GDP ratio of almost 300%. This is a ridiculous explanation.
The second diagnosis is that the fiscal expansion made by Bolsonaro at the end of his term will have such a huge impact on aggregate demand that they would put the Brazilian economy to work above its potential output. Well, the Brazilian economy still has a 10% unemployment rate, but in the case of a dual economy like Brazil, the unemployment rate is not such an important variable for us to assess the pressure over productive capacity. Why? Most of the jobs that have been generated in the Brazilian economy in the last two years and, mainly, now, after the beginning of vaccination against COVID-19, were jobs in the informal or subsistence sector of the economy, which are precarious jobs. So, the unemployment rate just a little below 10% hides a huge, disguised unemployment. There is no demand pressure on the Brazilian economy. So, in my view, the two justifications that the Central Bank uses to continue raising the interest rate are completely unfounded.
That’s what brings me to the question of what political economy is behind the increase in interest rates. The only reason I see for such insane policies is that this is a government that is at the end of its mandate. Everyone knows that Bolsonaro will lose the elections, that President Lula will be elected and there will be a change in macroeconomic policy. For sure, the interest rate will be reduced not at once but in a gradual way. So, the rentiers and the financial sector, which have a very thigh relationship with the Central Bank, are taking advantage of the last few months that remain of their absolute dominance over the Central Bank to make the largest possible income extraction from the rest of the society.
Moreover, each percentage point increase in interest rates generates an increase in government spending (debt servicing) of about R$30 billion (almost US$6 Billions), over a 12-month period. In this context, the recent increase of half a percent made means that it will add over the next 12 months approximately R$15 billion in government spending (US$ 3 billions), that is, a transfer of income from the rest of society to the richest 1% of R$ 15 billion.
In my view, what is happening is simply the ‘end of game´ effect, which means that the remaining time for plunder Brazilian Treasury with insane high level of short-term interest rate is ending, so it is necessary to increase the rate of plundering before it is too late. So, they are taking advantage of the government’s last days in office to make the most of it. Taking advantage of a government that is falling apart, which has no chance of re-election, to make the most of it, that is, it is pure plunder of the Brazilian economy.