Central Bank misalignment numbers – 05/18/2023 – Market

The Central Bank (BC) has maintained the Brazilian real interest rate as the highest in the world since 2022. The comparison of real interest rates and inflation data in Brazil with those of other countries suggests a clear misalignment in the performance of the Brazilian Central Bank.

The central objective of the Central Banks is to control inflation, using the interest rate for this purpose. In Brazil, the inflation target for 2023 is 3.25%. Accumulated inflation in the last 12 months has been falling and in April it was 4.65%. Inflation above the target is 1.4%. With the Selic at 13.75%, the real interest rate is 9.1%.

In a sample of 32 countries, four have inflation above the target at a level similar to that of Brazil: 1.2% in Japan, 1.3% in Indonesia and 1.7% in India and South Korea. All these countries have real interest rates much lower than Brazil (-3.3%, 1.4%, 0.8% and -0.2%).

In neighboring South Americans, inflation deviates more from the target than here: 8.1% in Chile, 10.3% in Colombia and 6% in Peru. Even so, the Central Banks of these countries have maintained real interest rates close to zero.

The contrast with the performance of BCs in developed countries, which are more technically and institutionally sound, is even more stark. In the Euro Zone inflation is above the target at 5%; 5.2% higher in Germany, 6.3% in Italy and 8.6% in Sweden. Real interest rates are negative (-3.4%, -4.5% and -7.1%, respectively). Other developed countries follow the same pattern, with higher inflation above the target (8.1% in the UK, 5% in Australia and 3% in the US) and real interest rates well below the Brazilian rate (-5.8%, -2. 1% and 0.2%).

These comparisons suggest a strong misalignment of the Brazilian BC in relation to the performance of BCs in the rest of the world. The situation changes little by taking the inflation projected for 2024 by the IMF. Real interest rates become positive and the differences between inflation and the target decrease in most cases. We continue with the highest real interest rate, but among the highest inflation differentials, partly due to the reduction of the target in 2024. This suggests that high interest rates have contributed little to reduce inflation. As the Nobel Prize in Economics, Joseph Stiglitz, recently pointed out, high interest rates discourage investment and hinder the reduction of supply bottlenecks.

In short, our Central Bank is accepting a much higher cost than others to keep current inflation more under control than the world average, given the targets. The fact that the other Central Banks are allowing inflation well above the target indicates the understanding that current inflation is temporary and resulting, to a large extent, from supply shocks (pandemic, war and oil prices). Low interest rates suggest the interpretation that the cost of keeping them high outweighs the expected benefits.

In the case of Brazil, which has unemployment close to 9%, informality of almost 40%, low investment, and which is seeking a fiscal adjustment, the cost of high interest is considerable. Do the benefits of the Brazilian Central Bank’s interest rate policy in terms of controlling inflation really outweigh the costs? Judging by the performance of BCs in the rest of the world, no. Why would the case of Brazil be so different? The Brazilian Central Bank’s justification for such misalignment is still unclear.