Change in inflation targeting system would not have impact in the short term, says Haddad – 06/28/2023 – Market

An eventual change in the format of the inflation targeting system would have no short-term impact on interest rate policy, said this Wednesday (28) Minister Fernando Haddad (Finance).

Without anticipating the content of the decisions, he said that the CMN (National Monetary Council) will discuss in a meeting this Thursday (29) the 2026 target and the possibility of adopting a continuous objective, a model in which the Central Bank needs to pursue certain level of inflation without being tied to a closed calendar year —as is the case today.

“We are going to guide this discussion at this meeting,” said Haddad. “I don’t think it has an impact in the short term. I consider it more of an improvement than what we consider to be working.”

The inflation targeting system is regulated by a 1999 presidential decree, which was amended once in 2017. Under the current model, the CMN —made up of the Ministers of Finance, Planning and the President of the Central Bank— needs to decide by 30 June of each year the inflation target that will be in effect three years ahead.

This year, therefore, the board will set the central target for monetary policy for 2026. For 2024 and 2025, the target has already been set at 3.25% and 3%, respectively, with a tolerance margin of 1.5 percentage points for more or less.

The decree also provides that the inflation target will be considered fulfilled when the accumulated inflation variation “relative to the period from January to December of each calendar year” is within the tolerance interval stipulated by the CMN. It is this article that spells out the rule that the government now wants to discuss.

To change the system, President Luiz Inácio Lula da Silva (PT) needs to issue a new decree. According to interlocutors, until the beginning of the evening of this Wednesday, there was no forecast for the publication of a decree to pave the way for a more concrete deliberation already at the meeting on Thursday.

In 2017, when the Michel Temer (MDB) government wanted to start gradually reducing the inflation target (until then at 4.5% per year) and define targets for up to three years ahead, a decree was published early in the morning of day of the extraordinary meeting of the CMN, held before the opening of business in the financial market.

According to reports, members of the Lula government are seeking a consensus position to change the inflation targeting system. The format to be adopted from 2025 is one of the points of discussion between those involved in the negotiations.

When making its interest rate decision, the Central Bank does not look at inflation today, but at the months ahead, since the monetary policy takes full effect on the real economy with a lag of about 18 months, according to current estimates. Therefore, there is an assessment that any change in the system for 2024 would produce few practical effects.

The year 2025 will begin to appear now, as of the August meeting of the Copom (Monetary Policy Committee), in the so-called “relevant horizon” of BC decisions, a period that enters into the analysis of the monetary authority when deciding the course of interest.

According to Lula’s interlocutors, despite the debate surrounding the possibility of adopting the continuous target, there is no forecast for raising the inflation target, with the exception that the president may want to review this position at the last minute.

At the Planalto Palace, despite the government’s recent quarrels with BC President Roberto Campos Neto, the preference is for the change in the system’s format to have the endorsement of the head of the monetary authority — who has a seat on the CMN.

In the words of Lula’s allies, a change in the goal’s horizon would be agreed within the CMN, but its final format will still be the subject of discussion. The debate has been closely conducted by Haddad and Campos Neto. At the Treasury, there is an expectation that Planning will align itself to form a government position on the subject.

The discussion is conducted with caution given the tension between the Central Bank and the government and also the sensitivity of the issue, as these are structural changes. One cannot rule out the possibility of the government issuing a firmer signal about the concrete objective of changing the target system, but implementing the process later on.

The Minister of Finance himself made a point of emphasizing that the government is acting “without haste” so that the most appropriate decisions are taken.

“No one is here inventing formulas or transforming the country into a laboratory. On the contrary, we are adopting good practices, bringing the best practices to effectively modernize our legislation”, stated Haddad.

While he said a short-term impact on interest rates was unlikely, the minister said improvement was “desirable”. He indicated that, in countries with targets pursued over longer horizons, the discussion has been more focused on the trajectory of convergence of inflation to the target than on new interest rate increases to meet it in a given calendar year.

“In Europe and the United States, nobody is discussing with the Central Bank how much the interest rate in the United States has to go for the 2% target to be reached. What is required is a path,” he said.