Transcript Brazil*s Stagflation Is a Classic Case of *Unpleasant Monetarist

Brazil’s Persistent Stagflation Is a Classic Case
of “Unpleasant Monetarist Arithmetic”
Joaquin A. Cottani
13 November 2014 – Sao Paulo
Like many central banks in the world, the BCB relies on
Inflation Targeting and the Taylor Rule to control inflation
18
16
14
12
10
8
6
2006
2007
2008
2009
SELIC
2010
2011
TAYLOR
2012
2013
2014
However, the results have been mixed
8.50
7.50
6.50
5.50
4.50
3.50
2.50
1.50
HEADLINE
CORE
TARGET
Surprisingly, the periods in which consumer inflation was
higher were also those in which GDP growth was lower
Period
2Q11-3Q14
1Q04-3Q14
1Q04-1Q11
1Q04-3Q08
2Q06-3Q08
GDP Headline Core
Growth Inflation Inflation
1.73
6.12
6.54
3.58
5.57
5.86
4.47
5.30
5.53
5.03
5.35
5.43
5.58
4.23
4.05
Real
Deviation from:
Selic Headline Core
3.76
1.62
2.04
6.81
1.07
1.36
8.28
0.80
1.03
9.80
0.85
0.93
8.18
(0.27)
(0.45)
Conventional Explanations for Stagflation Puzzle
• Potential growth has fallen so much in Brazil that even 1.7
percent actual growth is enough to produce demand-pull
inflation.
• Inflation stickiness is caused by the BCB’s perceived lack of
independence and credibility, and the solution is for the BCB
to rebuild its reputation by further tightening monetary policy
until inflation converges to the target.
• The interest rate is not so high when subsidized credit is taken
into account.
Alternative Explanation: “Unpleasant Monetarist Arithmetic”
• In Brazil, the Consolidated Federal Debt that includes the
monetary liabilities of the Central Bank is 70% of GDP. Three
fourths of this debt is held by commercial banks that
transform it into liquid assets.
• Liquid wealth (deposits + money-market funds) is an
important determinant of private consumption.
• The speed at which liquid wealth grows is influenced by the
interest rate paid on government debt through the effect on
budget deficit.
Brazil’s Financial Sector in Figures
(billion BRL)
Cash in Circ.
+ Bank Reserves
BCB Monetary Liabilities
Unremunerated
Remunerated
Fed Treasury's Debt
Consolidated Fed Debt
GDP
As % GDP
160
970
1,130
(250)
880
2,520
3,400
4,840
70%
Remun BCB Liabilities
Fed Sec owned by Banks
880
1,710
Fed Debt Owned by Banks
Consolidated Fed Debt
Banks' Share
2,590
3,400
76%
A Simplified Model
Suppose that:
Liquid Wealth = Public Debt = W
Nominal Interest Paid on Public Debt = INT
Primary Surplus = S
Potential Growth = G
Inflation = INF
(1) Change in W = INT - S/W
(2) INF = Change in W – G
What Causes Persistent Stagflation in Brazil?
• Primary surplus (S) is below target due to political and institutional
constraints.
• BCB tries to compensate by raising INT.
• “Sticky” INF causes INT-INF (real interest rate) to rise in short run
reducing investment, hence potential growth (G).
• Higher INT increases fiscal deficit making W grow faster.
• Since G is supply determined, INF increases in the long run.
• Conclusion:
INF
INT
G
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