Brazil, world champion of usury and inequality – the role (or cardboard) of the Central Bank

Today I will address a particularly complex economic issue – the Central Bank's interest rate policy. The article will be a bit more technical. Don't give up, however, reader. If you have difficulties with any paragraph or technical term, skip the passage and continue, or do some quick conceptual research online.

Since last year, under Roberto Campos Neto's administration, and in 2025, under Gabriel Galípolo's administration, the Central Bank has significantly increased the basic interest rate, the Selic. Real interest rates former before (The nominal rate discounted for expected inflation) rose to record levels, placing Brazil, once again, as the world champion or runner-up of usury. At the last meeting of the Monetary Policy Committee (Copom), the BC leadership indicated that interest rates will remain high for a long time, adapting more or less passively to the expectations of the financial market.

These moves by the Central Bank triggered intense controversy in the country. Many were against it, just as many were in favor. Who is right? The financiers, rentiers, and market economists, who usually defend high interest rates? Or the industrial sectors, other productive sectors, and more heterodox economists, who reject the Central Bank's policy? As the reader probably knows, I am in the second camp. 

The issue is more intricate than is generally imagined. Assessments should therefore be made with some care, which rarely happens. The usual exchange of slogans and adjectives produces, as always, more heat than light.

But this caution will not prevent me from being incisive in the article's conclusions.

Does a high interest rate policy really reduce inflation? At what cost? Some initial questions: can high interest rates actually control and reduce the inflation rate, as its proponents often claim? And, if so, at what cost in terms of adverse effects on GDP, employment, public finances, and national income distribution? Is it an effective policy? Is it also efficient? There is little doubt that high interest rates generally and significantly contribute to reducing inflation. Through at least three channels. First, because they compress aggregate consumer and investment demand in the economy, which exerts downward pressure on the prices of goods and services that are not internationally tradable (non-tradeables), including on labor remuneration. Secondly, because they tend to cause currency appreciation, which depresses the prices in reais of internationally tradable products (tradeables), both exportable and importable. Third, because the rise in basic interest rates, if seen as sustainable, normally reduces inflation expectations and, in this way, tends to reduce current inflation and long-term interest rates. Thus, a high interest rate policy is normally effective in reducing inflation.

However, this does not mean that it is efficient, as several factors limit its anti-inflationary effects and produce adverse side impacts. It is effective because it generates a drop in inflation; but it is not efficient because it achieves this result by producing great damage and side effects. 

Let's look at some of these factors. In a continental economy like Brazil's, the degree of external trade openness, measured by the ratio of foreign trade flows to GDP, is lower than that observed in small, open countries. In small countries, such as Switzerland, Belgium, or the Netherlands, among many others, where the degree of openness is very high and almost always well above 100%, the external appreciation of the national currency induced by high interest rates has a decisive impact on inflation. In the case of Brazil, which has a degree of openness of around 40%, the anti-inflationary impact of an external appreciation of the real, while not negligible, rarely becomes decisive. (It should be noted that in the United States, another continental economy, the degree of openness is even lower than ours, below 20%). In other words, the exchange rate appreciation required to achieve a certain drop in inflation is greater in countries like Brazil, which tends to undermine the international competitiveness of the economy and generate imbalances in the current account balance of payments.

A second aspect of the issue: there is always some rigidity in prices and wages towards the downside. In economies like Brazil, which has a long tradition of indexation, there is also some inflation inertia, that is, the tendency to bring past inflation into the present. Thus, the anti-inflationary effect of a given contraction in aggregate demand is less than it would be if prices and wages were more flexible and the inertial component of inflation were smaller. 

In short, for these and other reasons, significant demand contraction and/or currency appreciation are needed to reduce inflation and bring it within the target, especially when that target is set excessively ambitiously. This is what we have today – a legacy of the incompetent economic management of the Temer government, the one that was led by a supposed “dream team"As was said at the time in relation to the Treasury and the Central Bank. The Lula government should have, right from the start, increased the central inflation target and the range around it, as President Lula wanted. Nothing was done, however. The fear of displeasing the market prevailed in the economic area." 

Effects on public finances and the distribution of national income. High interest rates produce destructive side effects. Besides slowing down the economy, they destabilize public finances in two ways – directly (by overburdening the cost of public debt) and indirectly (via adverse effects of the contraction in economic activity on tax revenue and cyclical spending such as unemployment benefits). The public sector as a whole currently bears net interest expenses of around 8% of GDP! This component, and not the much-touted primary fiscal result, explains the public deficit and the growth of government debt. The primary deficit is around 0,6% of GDP.

And the problem doesn't stop there. When the government pays exorbitant interest rates, who receives the money? Who are the government's creditors? Fundamentally, financial institutions, the super-rich, the rich, and, to a lesser extent, the upper middle class, in addition to foreign creditors. High interest rates are, in fact, a powerful instrument for concentrating income in a country that has long been the world champion, or one of the world champions, in social inequality. It's also worth noting that this monetary policy puts reais (Brazilian currency) precisely in the hands of those who have a high propensity for capital flight during times of uncertainty, such as at the end of 2024 – a flight facilitated, it should be remembered, by the premature liberalization of the capital account, a regrettable legacy of the Fernando Henrique Cardoso administration. Thus, generous interest rates feed the monster of destabilizing currency speculation. The country suffers, and the wealthy celebrate.

No one is asking the new leadership of the Central Bank to make a U-turn on monetary policy. But, frankly, status quo?? Keeping everything as it was in the previous administrations of the institution??   

***Expanded version of an article published in the journal Capital letter.