Analysis | Why President Lula clashes with Brazil’s central bank

1. What is the central bank’s strategy?

A year ago, Brazil was one of the world’s first central banks to embark on an aggressive cycle of rate hikes, pushing the Selic reference rate from a historic low of 2% to 13.75% in September. Since then, policymakers have kept the cost of borrowing stable. Last year, inflation fell from a peak of over 12% to 5.87% in Brazil, the largest decline among emerging economies. But with an inflation target of around 3%, the bank’s policymakers are not done fighting rising prices. The decrease in inflation is mainly due to tax cuts approved under the previous president, Jair Bolsonaro; after three consecutive months of deflation — in July, August and September — the impact of the austerity measures is waning and transport and food prices are picking up again. Central bankers have signaled they can hold interest rates steady for most of 2024 to meet their goal of cooling Latin America’s largest economy and pushing annual inflation closer to 3.25% this year and 3 next year % to bring.

It may take a relatively long time for interest rates to slow down economic activity in Brazil. That’s because monetary policy works through the banking system by making loans cheaper or more expensive, and the proportion of people with bank accounts in Brazil is lower than in developed economies. After a year of rising interest rates, credit flows in the country are only now slowing down. Still, most analysts believe central bankers will succeed in cooling economic activity, forecasting growth of less than 1% this year, compared to an estimated 3% in 2022.

3. What is Lula’s complaint about central bank policy?

After taking office in January, the president repeatedly complained about monetary policy in TV interviews and public speeches. He called current interest rates an “embarrassment” and said there is “no reason” to keep them this high. He has argued that the bank’s target of around 3% inflation is not appropriate for an emerging market like Brazil and should be 4.5% instead. It came closer to that during Lula’s previous two terms in office. The extent to which central bankers were allowed to miss their target, the so-called margin of tolerance, was also higher then. The bank’s ambition to slow economic growth complicates Lula’s ability to deliver on his campaign promises to raise living standards for all Brazilians and increase government revenues to improve public finances.

4. How has the central bank responded?

Policymakers led by Campos Neto sounded the alarm about inflation risks and reaffirmed their commitment to their mission. After Lula first voiced his criticism, analysts, who had already predicted inflation rates above 3% through 2026, raised their estimates further. Soon after, in their first public communication this year, central bankers said they “remain determined” to achieve their goal. They have also warned of “extremely uncertain” fiscal prospects after Lula was given the green light by Congress for 168 billion reais ($32.4 billion) in extra-budget spending. Some members of the bank believe pledges to reduce the government deficit “should reduce that risk,” the public statement said.

5. Is central bank independence at stake?

The repeal of the central bank’s autonomy bill seems unlikely given that many members of Congress have confirmed their commitment to it. More likely is a debate on changing the bank’s inflation targets in June, when the National Monetary Council is expected to set a target for 2026. Two members of Lula’s cabinet, Finance Minister Fernando Haddad and Planning Minister Simone Tebet, form a majority on the council. , with Campos Neto the third member. Campos Neto was appointed to his position by Bolsonaro and has pledged to remain in office until the end of his term in December 2024, at which point Lula will nominate a replacement, subject to congressional approval. During his previous terms, Lula gave the central bank the freedom to decide on rates, but he had then elected the leader, Henrique Meirelles. The terms of office of the bank’s monetary policy and supervision directors expire at the end of February, and Lula will nominate their replacements to Congress amid this conflict.

6. What is the argument for central bank independence?

A much-cited 1993 paper by economist Alberto Alesina and former U.S. Treasury Secretary Lawrence Summers concluded that independent central banks can manage inflation better than central banks under political control. Shielded from the pressures of day-to-day politics, the newspaper said, they can take a longer look and make unpopular decisions to get there.

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