MNI: Covid Supply Shocks A Lesson - ExBCB's Guardado

Monetary policymakers must pay closer attention to the potential for supply side disruptions to disrupt their projections as occurred during the Covid pandemic, said former Central Bank of Brazil deputy governor for international affairs Fernanda Guardado, whose recent published work describes how the BCB chose to err on the side of caution and hiked aggressively as inflation surged.

"The biggest challenge during the pandemic was making decisions in an environment of high uncertainty and without historical precedents for comparison," Guardado, who is still in her six-month quiet period after leaving the BCB in January, told MNI. "As evident in several chapters of the book, an important lesson was to better analyze the supply side and its disruptions on the economy and the projections of the models usually used by central banks," she said.

In a chapter contributed to the recently-published "Monetary Policy Responses to the Post-Pandemic Inflation", promoted by the Centre for Economic Policy Research (CEPR), Guardado wrote that the BCB opted to err on the side of caution in order to avoid the danger that inflation would get out of control.

"The BCB opted to minimize the risks of remaining ‘behind the curve’ as inflation surprised upwards, acknowledging that the costs of bringing down inflation might rise steeply if credibility is lost," she wrote.

In her chapter, Guardado recalls that between March 2021 and August 2023, Brazil increased its official Selic rate by 1,175 basis points from 2% to a peak of 13.75%, the highest level since 2016.

ACTING FAST

"Despite starting the fight against the global inflation spell that took place after the pandemic earlier than most, the persistent deterioration in prices, expectations, and the balance of risks led the BCB to increase the pace and revise the total size of the hiking cycle, or budget of hikes, several times throughout that process," she said in the book.

"The BCB chose to act in a fast and timely manner to the budding inflation risks evident by the beginning of 2021 and implemented the largest and fastest tightening cycle in its inflation targeting history. As disinflation proceeds in 2023, the strategy seems to be working, but a scenario still full of risks and uncertainties continues to demand caution on the part of central bankers," her work concludes.

Still facing the pandemic effects and the Ukraine War, the BCB monetary policy committee (Copom) kicked off an easing cycle in August 2023 and since then has reduced its interest rate by 325 basis points, to the current 10.50% level. The board kept the 50bp pace until the last meeting in May, when it decelerated to 25bp and offered no guidance for June. (See MNI POLICY: BCB Pause In Sight, But Copom Consensus In Doubt)

"As evident in several chapters of the book, an important lesson was to better analyze the supply side and its disruptions on the economy and the projections of the models usually used by central banks," she told MNI.