Galípolo as director at the Central Bank: will interest rates fall? – 09/05/2023 – Bernardo Guimarães

The government announced this Monday (9) that Gabriel Galípolo, the current executive secretary of the Ministry of Finance, will be the new director of Monetary Policy at the BC (Central Bank).

Galípolo, linked to Haddad and Lula, is seen as someone who will defend lower interest rates.

However, as soon as it was announced, long-term (five to ten years) market interest rates increased noticeably. Interest embedded in government bonds maturing in 2030, for example, rose.

Why did this happen? What does this tell us about monetary policy?

The interest rate is the instrument that the Central Bank uses to control inflation. When it is expected that the autarchy will not hesitate to raise interest rates, inflation expectations are lower.

Inflation expectations affect inflation itself by influencing price adjustments and wage negotiations. Thus, low expectations make it easier for the central bank to control.

Because of this, central bankers around the world often signal an aggressive stance against inflation. Like a wild beast that enters territory showing its claws, these directors have incentives to vote for higher interest rates at the first few meetings.

This is exactly what two researchers found when studying the votes of members of the UK monetary policy committee (their Copom). In the first few months, they are as rabid as dogs against inflation. Many, afterwards, remain tame as kittens on the ground.

Incidentally, the effect is even stronger for those who are, in general, less in favor of high interest rates against inflation. Beasts that already have a reputation for being aggressive don’t have as much of a need to show fury when they arrive.

In short, expectations of a more aggressive stance to bring down inflation tend to lead to lower inflation.

Gabriel Galípolo, however, arrives at the Central Bank signaling a less aggressive stance against inflation. He is an important player on the team that criticizes high interest rates.

In addition, he is the second name in the hierarchy of the Ministry of Finance, just below Fernando Haddad. Thus, the BC’s Monetary Policy directorate is not exactly a promotion. Why did he go there? It is speculated that perhaps he is going with a view to becoming BC president at the end of 2024, when Roberto Campos’ term expires.

If that is the case, and if Galípolo is indeed afraid of raising interest rates in the future, we may have higher inflation in a few years.

The last part of the argument is that higher inflation tends to lead to higher interest rates, even if the Central Bank doesn’t want to.

If inflation goes from 4% to 8%, the nominal interest rate needs to rise by four percentage points so that the real interest rate (discounting inflation) remains constant. This is important because it is the real interest rate that affects investment decisions and the demand for goods in the economy.

Furthermore, if inflation rises, the Central Bank must at some point raise interest rates to bring it down.

In fact, the highest nominal interest rates in Brazil in the last 15 years were observed at the beginning of Dilma Rousseff’s second term, precisely because inflation reached 10% per year.

In soccer, defenders who believe the referee will be lenient make more fouls. Often, the judge who doesn’t like showing cards ends up having to eject someone.

Inflation expectations and, consequently, inflation and interest rates also react to what is expected from the Central Bank.

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