Beyond inflation – Brazilian style

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Capital controls look as likely as inflation targeting in upcoming monetary policy.

With all the recent talk of Ben Bernanke’s new unemployment rate-related and GDP growth-focused monetary policy mandate for the Federal Reserve, and comments from soon-to-be Bank of England governor Mark Carney reinforcing this shift away from myopic inflation-targeting, it is perhaps worth remembering that in Brazil the central bank has long looked beyond its official target of inflation of 4.5% plus or minus two percentage points. One of the aims of monetary policy has been to reduce interest rates as a target in itself, to lengthen the terms of financing within the economy, to spur investment and in turn to generate GDP growth. The drive to a lower Selic rate was also crucial, in the government’s eyes, to reduce the inflows of speculative money into the currency and thereby lead to a lower valuation of the real.

It’s harder to forecast, when there are so many aims for monetary policy – official and unofficial, but widely known – what will happen to Brazilian rates in 2013. There is quite widely expressed confidence in the country for renewed GDP growth in 2013. Despite the woeful performance in 2012, when GDP is likely to have hit an annual growth rate of about 1%, bankers say that companies across industries are reporting a strong close to the year. Domestic Brazilian optimism and confidence are definitely growing, and there are lessened fears of calamitous external shocks. If the optimism is correct, the growth will likely lead to an increase in inflation. Will that, in turn, mean increased interest rates?

Not necessarily. There is a minority, but important, school of thought that the government will throw the capital-controls rule book at any heat in the economy rather than increase rates. This view derives from a simple belief that because the exchange rate is central to the government’s economic strategy, it doesn’t want the real going below its current range of R$2.00 to R$2.10 to the US dollar.

So instead of increasing interest rates, the IOF taxes on financial operations might be extended, altered or increased. Industry-specific policies might be adopted to put brakes on inflation – already seen in utilities, electricity and oil – with the predictable negative follow-on effects to companies’ share prices and investment levels in those sectors. Altogether, such an approach will certainly make it harder to predict any financial policy changes, and might have the unintended (or is that intended?) consequence of lessening the appeal of Brazil to investors from abroad.

A country is free to pursue its own economic strategy, of course, (within reason, that is, Argentina take note) and Brazil is a great example of a country that is willing to adapt conventional thinking and take its own path. It is among those countries that have been ahead of the curve in its approach to its "beyond inflation" objectives for monetary policy. But it also shows that while it is easy to broaden the demands of monetary policy – it’s easy to add in employment targets, GDP growth and even currency valuation to the inflation-targeting mandate – the follow-through implications tend to be complexity, uncertainty and, well yes, a little messiness.