Inflation target needs to rise to avoid too high interest rates, says ex-BC

To deal with the high price shock and avoid a sharper drop in economic activity, the Central Bank (BC) will have to adjust the inflation target upwards in 2022 and for a few years ahead.

This is the assessment of Sérgio Werlang, former director of Economic Policy at the BC, one of the authors of the target system model adopted in the country in 1999.

The inflation target for this year is 3.50%, with a tolerance range of 1.5pp up or down. The target drops to 3.25% in 2023, and 3% in 2024, with the same band for accommodating unexpected shocks.

Between 2005 and 2018, the target was stationary at 4.5%, being met with a very close result only twice, in 2007 and 2009.

“The reduction of targets has become a trap for the BC to fulfill its mandate. With a falling target, the Copom has to be tougher than it should be (increasing interest rates). Now, when there is an explosion like the one we are experiencing now, he will have to be even more conservative. An exceptional situation that would justify a review of the targets”, said Sérgio Werlang in an exclusive interview with CNN.

Werlang has been calling attention to the risk of the country living with such low inflation targets, around 3%, without having carried out the administrative reform, a fundamental condition for promoting a continuous reduction in public spending.

The cost to GDP growth will continue to be high because of a much higher interest rate to avoid price runaways.

“The fiscal argument is also sufficient. As long as there is no consistent balance of public accounts, the solution will be for the country to have more inflation. It can start with the salaries of civil servants, making the readjustment of the civil service to be made only below inflation, since it is not possible to dismiss or reduce salaries in the public sector. This would already help the Central Bank a lot”, said the former director of the BC.

Sérgio Werlang, one of the authors of the goals model and responsible for its implementation in 1999, suggests that the 2022 objective be readjusted to 4.5% and for the next years to 4%.

He recalls that the measure was already taken in 2003 and 2004 after the 2002 crisis, which took IPCA to 12.5% ​​that year. The initial target for 2003 was 3.25% and went to 8.5% to avoid the base rate having to rise until it causes a recession in the economy.

“We will only have a lower goal after carrying out the administrative reform. Before that, you can’t cut costs, so you can’t have such low inflation. We have to work on it so it doesn’t snowball. After the reform, then we can set 3% as a long-term inflation target”, argues Werlang.

The former director of the BC points out that it is possible to maintain the goals as they are before the reform is approved.
Copom would have to “choose a number a little above the target” and not be a purist with the system’s rules. The column recalled the years under the mandate of Alexandre Tombini in the presidency of Dilma Rousseff’s BC, when the objective of the monetary authority became, not explicitly, the so-called “target ceiling”, the upper indicator of the tolerance band.

“It can be done, but it’s not perfect. The BC would reach a number slightly above the target and raise interest rates to guarantee this objective”, he argued.

I asked about the risk of loss of credibility if the BC repeats the mistake of reducing the transparency of monetary policy.

“The BC has already lost some of this credibility. What is the fastest way to get it back? I don’t know the 100% right answer, but it seems to me that the most correct is to change the inflation targets and promote lower economic costs for the country”, he concluded.