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Why President Lula Is Clashing With Brazil’s Central Bank

When Luiz Inacio Lula da Silva was Brazil’s leader from 2003 to 2011, he didn’t have to contend with an independent central bank. Reelected president in October, he’s resisting the new reality created by a 2021 law enshrining the bank’s power to set monetary policy autonomously. He has called the law “nonsense” and publicly criticized the bank’s inflation goals and interest rates, creating tension with its chief, Roberto Campos Neto. The bank has set its benchmark interest rate at a six-year high and signaled readiness to hold it there to combat inflation. The left-wing Lula, for his part, wants borrowing costs lowered to boost economic growth and deliver on his campaign promises of “steak and beer” for all. More recently, there have been signs that both sides may be willing to at least lower the temperature of the debate.

1. What has the central bank been doing? 

Brazil’s was one of the world’s first central banks to embark on an aggressive cycle of hiking interest rates, moving in 2021 to take its benchmark Selic rate from historic lows of 2% to 13.75% by September 2022. Policy makers have held the cost of borrowing steady since. Inflation fell in 2022 from a peak of more than 12% to 5.77%, the biggest drop among emerging economies. But with an inflation target of around 3%, the bank’s policy makers aren’t through combating rising prices, especially since much of the price reductions came from cuts to taxes on gasoline and sales taxes approved under the previous president, Jair Bolsonaro. Those cuts contributed to three consecutive months of deflation, or falling prices, in July, August and September. But the impact of the cuts is fading, and transportation and food prices began picking up again in 2023.  

2. Where did that leave bank policy?

Central bankers have signaled that they could keep rates steady through most of 2024 to achieve their goal of cooling down Latin America’s biggest economy and bringing annual inflation closer to 3.25% this year and 3% next. It can take a relatively long time for interest rates to slow economic activity in Brazil, as is true of many developing countries. That’s because monetary policy works through the banking system by making loans either cheaper or more expensive, and the share of people who have bank accounts in Brazil is lower than in developed economies. After a year of rising interest rates, credit flows are only now slowing down in the country. Still, most analysts believe central bankers will succeed in cooling off economic activity, and they forecast growth of less than 1% this year compared with an estimated 3% in 2022. 

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

After taking office in January, the president complained repeatedly about monetary policy in TV interviews and public speeches. Slower economic growth could hinder his ability to deliver on his campaign promises of lifting living standards for all Brazilians and boosting government revenues to improve public finances. Lula called current interest rates an “embarrassment” and said there’s “no reason” to hold them so high. He’s argued that the bank’s target of about 3% inflation isn’t appropriate for an emerging market such as Brazil and should instead be 4.5%. During Lula’s prior two terms in office, the target was closer to that. The extent to which central bankers were allowed to miss their target, known as the tolerance range, was also higher back then. 

4. How did the conflict develop?

After Lula first aired his criticism, analysts, who had already forecast inflation rates higher than 3% all the way through 2026, boosted their estimates further. Soon after, in their first public communication this year, central bankers said they “remain committed” to hit their target. They have also warned about a “particularly uncertain” fiscal outlook, after Lula received a green light from congress for 168 billion reais ($32.4 billion) in extra-budgetary spending. Some members of the bank believe pledges to reduce the government’s deficit “should mitigate” that risk, according to the public communication. 

5. Is there any sign of a resolution? 

On Feb. 13, Campos Neto appeared in a rare TV interview and pledged to do “everything” he can to be closer to the new government. Days later, Lula appeared to tone down his criticism of the central bank chief, who he had previously referred to as “that citizen.” During an interview with CNN Brasil he said it’s not part of his job to be “fighting” with the central bank, though he continued to question the monetary authority’s autonomy while arguing that lower interest rates would boost the economy. Still, investors worry the ongoing dispute could impact monetary policy, after news broke about the possibility of an early review of inflation goals by the National Monetary Council, which sets the inflation targeting regime, something that had been scheduled to happen in June.   

6. Is the central bank’s independence at risk? 

The repeal of the central bank autonomy law seems improbable given that many members of congress have affirmed their commitment to it. More likely would be a debate about changing the bank’s inflation goals when the National Monetary Council meets again 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 named to his position by Bolsonaro and has pledged to remain in the job until the end of his mandate, in December 2024. At that point, Lula will nominate a replacement, who must win congressional approval. During his previous terms, Lula gave the central bank freedom to decide on rates, but he had chosen its leader at the time, Henrique Meirelles. The mandates of the bank’s monetary policy and supervision directors will conclude by the end of February, and Lula will nominate their replacements. 

7. What’s the argument for central bank independence?

A widely cited 1993 paper by economist Alberto Alesina and former US Treasury Secretary Lawrence Summers concluded that independent central banks are better at controlling inflation than central banks under political control. Shielded from pressures of day-to-day politics, the paper said, they can take a longer view and make unpopular decisions to get there. Critics say independent central banks are too secretive and put commercial banks’ interests before taxpayers’, so more public control is better. 

Source : Washingtonpost