Opinion: how Lula da Silva is making Brazil a high-risk country for inflation again

(Opinion) The monetary authority headed by Roberto Campos Neto warned about the dangers of fiscal irresponsibility manifested by the new Brazilian government.

The squandering of the surplus inherited by Bolsonaro could collapse all efforts in the fight against inflation.

The spendthrift proposals announced by President-elect Lula da Silva threaten to overthrow the climate of price stability conquered by Jair Bolsonaro, according to the latest inflationary records surveyed by IBGE.

The Central Bank of Brazil, led by economist Roberto Campos Neto, warned Tuesday in an official statement that Lula’s socialist proposals could not only limit the monetary policy’s capacity for action but also affect price stability and the progress achieved so far.

Lula da Silva proposes to eliminate the ceiling on public spending for a period of 4 years, the corresponding budgets will not have to obey the fiscal rules that Brazil so disciplined adopted.

An increase of R$145 (US$27) billion is proposed over the public spending budgeted for 2023, which will be destined to social subsidies that favor the networks of political clientelism.

No proposal or project was presented to explain where the resources to finance the new spending path will come from.

Lula da Silva’s team did not present a tax reform, and analysts estimate that the main instrument for financing the deficit will be indebtedness, but this has a limit, and the most dangerous alternative is monetization.

The Brazilian Central Bank Committee explained that the effectiveness of monetary policy is explained by its different transmission channels: asset prices, the exchange rate, aggregate demand, interest rates in the financial system, and expectations, which in short, underpin the credibility (or not) of the inflation targeting program.

An irresponsible fiscal policy to increase the deficit amid such a delicate scenario as the current one threatens to deteriorate inflationary expectations in Brazil, fearing the return of fiscal dominance over monetary policy, something that Bolsonaro had managed to eradicate with a consistent package of measures.

Even with legal independence and carrying out a restrictive monetary policy, if the federal government insists on a path of permanent fiscal imbalances and is faced with the limitations of financing itself with constant indebtedness, the only possible alternative would be monetary financing of the fiscal deficit.

The markets could anticipate this scenario by provoking a fall in demand for reais, thus inducing a resurgence of inflation and the loss of effectiveness of the Central Bank’s monetary policy.

Lula da Silva’s outlandish statements did not help to regain confidence, but rather the opposite.

The President-elect stated without fear of being mistaken that “it is absurd to have an independent central bank”, referring to the reform promoted by Jair Bolsonaro in 2021.