The National Monetary Council (CMN) has decided today (6/26) to keep the inflation target for 2009 in Brazil at the current level, 4.5% +/- 2.0%. This target is at the upper extreme of inflation targeters, even emerging market ones. As the Table shows, the current inflation forecasts for the next 2 1/2 years are below 4%.
Therefore, the most likely outcome of the recently announced target will be to raise inflation expectations. Given that the Expectations Augmented Phillips curve prescribes that higher inflation expectations will raise actual inflation, ceteris paribus, it follows that for any given actual inflation achieved, the Central Bank will have to set higher interest rates than it otherwise would. In other words, today´s decision will make harder, not easier, for the Central Bank to keep lowering interest rates. This point seems to have been missed in the discussion.
The statements after the decision made the whole story worse. The Finance Minister, who wanted the 4.5%, declared that the decision was taken to provide more flexibility to monetary policy, but that the objective is to keep inflation expectations as they are, below the target. The Central Bank governor, who wanted the 4.0%, said that the decision does not imply that the Central Bank will try to make inflation converge to 4.5%, and that the current inflation expectations should be maintained.
Both remarks highlight that it was a split decision, and that the inflation target regime in Brazil may be losing something that the Central Bank achieved at a very high cost, the very credibility of the inflation target. What is the point to announce a target that will not be pursued?
Economic policy stance has been deteriorating steadily in Brazil since 2006. Today´s decision just strengthens this unfortunate trend. Someday, markets may notice.