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Economy Ministry’s projections foresee 2.5% GDP expansion and drop in inflation next year

19/09/2022

Economy Ministry’s building in Brasília — Foto: Marcelo Casal Jr/ABr

Macroeconomic projections unveiled on Thursday by the Economy Ministry maintained an apparently optimistic tone, foreseeing relatively strong GDP growth and falling inflation at the same time.

The scenario outlined by the Secretariat of Economic Policy (SPE) includes GDP growth of 2.5% in 2023 and a slowdown in inflation to 4.5%, compared with 6.3% this year. In addition, it expects the downward trend to continue thereafter, to get “close” to the target in the following years.

In the document, the ministry does not detail what could lead to this drop in inflation. Financial market analysts also predict a decline in inflation, but without convergence to the target before 2025. To have disinflation, however, they count on a 0.5% GDP drop in 2023.

In the interview that presented the projections, SPE’s team defended the thesis that Brazil’s potential GDP is higher. In other words, they say it is possible for the economy to grow faster without pressuring inflation.

This would be the result of several factors: higher capital expenditure and imports of capital goods; more formal jobs, which are more productive; and stronger growth in technological services.

The bulletin does not say directly what the potential GDP estimated by the SPE is, nor does it present more elaborate calculations about how it might have grown due to these factors. But everything indicates that it would be a number close to 2.5%, because this is the expected long-term growth, until 2026.

It is a slightly more optimistic percentage than the market consensus; the Focus bulletin projects a 2% rise in the long term. But it is high if compared to growth rates seen in the last decades.

A point that draws attention to the Treasury’s projection is the expected growth of 2.5% next year, close to the potential GDP, while inflation is seen as slowing down.

Inflation can lose steam for a number of reasons – such as a positive external shock or an improvement in economic agents’ expectations about price indices – but the only secure way for the Central Bank to tame inflation is by slowing down activity to create economic slack.

The document does not detail whether, in the ministry’s view, there is an economic slack now – a hypothesis that the market considers increasingly unlikely given the high core inflation more closely linked to the economic cycle.

The Economy Ministry’s projections do not have much importance for the policy of fighting inflation, since the Central Bank is a great specialist on the subject and operates according to its own models. But it is an important input for outlining the fiscal scenario. If one of the two – inflation or real GDP growth – is overestimated, it means that the nominal GDP used in the calculation of revenues may also be inflated.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/

In practice, this reflects stronger GDP expansion and lower-than-expected unemployment rate

07/01/2022

Central Bank’s building in Brasília — Foto: Jorge William/Agência O Globo

It was not only supply shocks and other surprises that made the Central Bank revise upwards its inflation projections. There were also the impacts of the lower-than-estimated degree of economic slack and the higher neutral interest rate, according to the Inflation Report released by the monetary authority Thursday.

Since March, the Central Bank increased its inflation projection for 2022 by 2.5 percentage points to 8.8%. A good part of this increase is due to the war in Ukraine, which has caused the prices of oil and other commodities to surge and disrupted production chains due to China’s zero Covid policy.

But the revision in the inflation projections, to some extent, is due to the fact that the Central Bank overestimated the degree of economic slack at the beginning of the year.

In March, the monetary authority had estimated that the so-called output gap, a measure of the economic slack, would be 1.8% at the end of the first quarter. Thursday’s Inflation Report redoes this calculation and finds that, in fact, the slack was 1.1%.

From the point of view of the real sector of the economy, this is good news. In practice, it reflects stronger GDP expansion and a lower-than-expected unemployment rate. The Central Bank has increased its estimate for GDP in 2022 to 1.7% from 1%. But on the other hand, this means that economic slack has not been as strong a driver of lower inflation as expected.

In the second quarter, another surprise: the Central Bank estimated the economic slack at 2%, but according to the most recent estimate in Thursday’s report, it has been revised downwards to 1.3%. A good part of the consequences of this lower-than-expected slack is still expected to reach inflation, which reflects the output gap with a few quarters of delay.

Economic activity was stronger than expected, in part due to the reopening of the economy with vaccination and a lower number of deaths from Covid. But GDP data for earlier this year also reflect last year’s still expansionary monetary policy and fiscal expansion measures.

Another factor that contributed to increasing Central Bank’s inflation projections was the revision of the neutral interest rate. In its June meeting, the Central Bank’s Monetary Policy Committee (Copom) increased its view on the neutral interest rate to 4% from 3.5%.

The market had already revised its estimates to 4% by the end of 2021, due to the high fiscal risk amid tax-cutting measures and spending expansion during the election. But the Central Bank made the move in two stages, raising it to 3.5% from 3% in December, and now to 4%.

A consequence of this is that the economy has seen, before the revision of the neutral rate, a monetary tightening lower than the one estimated by the Central Bank. The monetary tightening represents the difference between the real interest rates forecast by the market and the neutral interest rate.

In Thursday’s Inflation Report, the Copom says that the monetary tightening is lower than previously estimated, in March, until the first half of 2023, precisely because the neutral rate has risen. The tightening is higher in the second half of 2023, because the market now expects a higher Selic policy interest rate for the period.

In practical terms, this higher neutral interest rate leads to a higher inflation projection not only for 2022, but also for next year, which is the relevant horizon for monetary policy. The Central Bank has revised its inflation projection for 2023 by 0.9 percentage points, to 4%.

The Inflation Report says that other factors have also contributed to the rise in projected inflation this year, such as rising inertia and deteriorating inflation expectations. Inertia and expectations, in turn, may have been affected by inflationary surprises and higher price indexes in the short term. But they are also determined by the degree of monetary tightening and the level of economic slack, as well as fiscal uncertainty.

*By Alex Ribeiro — São Paulo

Source: Valor International

https://valorinternational.globo.com/

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