MNI INTERVIEW:Policy Pivots Unmoor Expectations-Ex BCB's Viana

Abrupt central bank policy shifts which undermine perceptions of commitment to an inflation target do long-term damage to price expectations, a former Central Bank of Brazil deputy governor told MNI after co-authoring a paper on a surprise rate cut by the BCB in 2011.

Microdata from the BCB’s Focus Survey revealed the impact of the decision in August 2011 by its Monetary Policy Committee Copom to cut its policy rate by 50 basis points with no warning at a time when it was in a tightening cycle, in a move widely interpreted as giving in to political pressure, according to the paper by Carlos Viana de Carvalho and others published in March. Market expectations had been for unchanged rates, or even a 25bp hike.

"After the Copom meeting, Focus BCB market survey inflation expectations became unanchored the next day, as the paper shows. In two days, they rose by 0.2 percentage points, which is a significant jump in a short time," Viana, now head of research at Kapitalo Investments, said an interview.

It took five years for Focus survey projections to return to target, he noted.

"Projections remained around 1 percentage point above the target in the long term, but over time other factors also influenced, such as the growing perception that fiscal policy was fragile and the exchange rate," explained the former official, who also worked as an economist at the Federal Reserve Bank of New York. "Based on this episode, which we call an abrupt U-turn, we provide strong evidence in the paper that this sudden movement indeed caused the unanchoring of expectations.”

WEAKENING COMMITMENT TO TARGET

While the BCB justified its shift as a response to global disinflationary shocks, press reactions and comments by former chairmen and governors revealed a different perception -- that the central bank had weakened or even abandoned its commitment to its inflation target, possibly as a result of political pressure for loose monetary policy, the paper argues.

"We show that the Focus saw it as a change of goal, as inflation expectations rose and interest rate expectations fell. Generally, when we think the scenario is worsening, the interest rate moves in the same direction. At that time, the direction was opposite,” Viana said.

Expectations remained unanchored until after the impeachment of then-President Dilma Rousseff in August 2016, which brought a new direction for economic policy.

The 2011 U-turn was unique in recent Brazilian monetary policy history, Viana stressed.

"Central banks surprise the market all the time, cutting or raising more than expected, but in this case, it was an abrupt change of monetary direction," he said.

His co-authors on the paper were Marco Bonomo, from Brazil’s Insper university, Stefano Eusepi from the University of Texas, Marina Perrupato, from the IADB, Daniel Abib, from the University of Western Ontario, Joao Ayres , from the IADB, and Silvia Matos from the FGV EPGE school of economics.