The government’s incompetence in the face of the complex situation adds seriousness to the trajectory present since before the pandemic. According to the IBGE, the contraction was already occurring in the first quarter of 2020. We were moving towards the fourth year in a row, with growth close to 1.0%.
Low inflation, low interest rates, low confidence. The collapse of activity, employment and income has determinants in social distance, but not only.
The impacts of the recession on public accounts frighten the market, just as the imminent contraction of income scares families and much of the non-financial sector.
If nobody invested before, what to say next? And, if the government expects to cut spending, what is the rationale for returning to previous levels of production and risking investment?
If the mediocre performance of the economy cast doubts in relation to the “expansionist” fiscal adjustment, doubts are becoming convictions. The number of analysts who remember the denominator of the debt / GDP ratio grows. The number of believers falling with cuts in spending has fallen.
The recent bitterness of the market was due to the frustration of the surprising expectation about the existence of the will and capacity of the government to maintain the fiscal regime. While central banks are dedicated to “doing what is necessary” for the economy to grow, the search for an adequate trajectory for public accounts comes down to “doing what is necessary” to keep public spending within the ceiling.
There are arguments that explain the convenience of controlling public accounts. The institutional design of the mechanism can be good or bad. The current one sucks.
It forbids the government to engage in anti-cyclical fiscal policy. The argument is twofold: we already did it and it went wrong, due to incompetence; and it will lead the market to raise interest rates, inhibiting the recovery instead of helping.
The question of incompetence is more ideological than technically and historically wrong. The interest issue has come up with more emphasis.
The expectation that leaving the ceiling is to increase the debt and / or “issue, because the money is over”, and that this would lead to more inflation, would explain the rise in future interest rates on the market, as the Central Bank will be led to raise the rate as the expected inflation rises.
Inflation resulting from the abandonment of the ceiling would come from the demand created by public spending and / or income transfer, devaluation of the real and the consequent increase in costs that would be passed on to prices.
Service prices grew for a long time around 8%, due to strong demand and fragile supply growth. Today, it is at 1.0%, falling since the 2015-16 recession destroyed employment and income. Inertia has been declining with changing labor market conditions.
The administered prices were dammed in the Dilma government and adjusted in shock in 2015, along with the exchange rate shock when the government sent Congress a budget bill with a primary deficit. A clash of expectations.
The food price shock, via IPCA, throughout 2014 and mid-2016, pulled the IPCA up and down. Since 2016, core inflation has been at extremely benign levels. Is there a coincidence with the change of government and command in BC?
The government continued to spend, preparing the ceiling. The new BC would soon show that one thing is the inflation targeting regime, another thing is an exchange rate targeting regime.
Depending on the intensity and duration of the cost shock, its transfer to prices depends on demand conditions. A cost shock, say, via the exchange rate, can be passed on to consumer prices as long as it sanctions them by paying them.
If the transfer is made, the consumer’s income falls. If not, the company’s margin drops. What will happen depends on the conditions of the labor market. If income is not expanding, the cost shock does not become inflation, but erosion of income and margins. The famous recession.