Since 2005 inflation expectation in Brazil is remarkably tamed. It is really great news, especially because of the country’s history of high inflation and heterodox plans. Not only inflation expectation is under control, but also its inertial component has faded away. Starting on September 2005, Brazil’s Central Bank has gradually decreased the interest rates in a clear process of convergence towards the international level. In spite of the fact that this process was interrupted in the last meeting of the Monetary Policy Committee, it is expected to be only a temporary pause. Brazilian policymakers have shown commitment to good monetary policy and this might explain the extraordinary recent behavior of domestic inflation.
Taking a look at the inflation rates worldwide it can be easily seen that low inflation is pervasive, despite the price increases of oil and commodities. Naturally, the inflation dynamics can be fairly explained by the dissemination of credibility and good reputation in line with sound monetary and fiscal policies adopted not only in developed economies, but also in developing and ex-troublesome economies like Brazil.
Although credible policymakers matter, other elements could explain the current success in taking domestic inflation under control. The literature on the role played by the global effects on domestic inflation, labeled as globe-centric models, has been growing lately. An increasing amount of economic literature studies whether the Phillips curve wouldn’t be flatter so that domestic inflation responds less to the internal factors according to widely used country-centric models.
As any controversial issue, other authors found modest and limited effects in big economies like the North-America, even with the vigorous trade growth between the United States and China and India. In the theoretical perspective, since that the markups operate far more cyclically, elements of globalization, therefore, could not explain the current deflationist trend.
According to the IMF/World Economic Outlook (2006) the global effects flattered the Phillips curve as can be seen in the diminishing of the output gap in the inflation equation from an average of 0.27 in 1983, to an average of 0.17 in 2004. Other authors believe that an increase in international competition squeezed markups and made the prices more flexible, forcing the central banks to react more aggressively.
We assessed the effect of the external factors on the Brazilian inflation dynamics, since the adoption of the inflation targeting regime, in mid 1999. It turns out that the coefficient of the domestic output gap in the country-centric model (conventional model adopted by the central bankers) averages 0.45; and such coefficient for the global-centric model (which takes into account elements of globalization) drops significantly to values around 0.25.
Remarkably, in our estimations, the reduction of the domestic output gap and the statistical significance of the global variables (foreign output gap, value of world imports, and trade openness) indicate at first glance the acceptance of the hypothesis that global factors matter for domestic inflation, especially in emerging market economies like Brazil. Most likely, the deflationist process that took place in Brazil was positively influenced by what happened abroad.