The excessive interest rates

by César Locatelli

"The rise in interest rates is a process that concentrates income, is unfair, uncertain, and unequal. And it involves public choices, far beyond the responsibilities of the Central Bank." This is the conclusion of the chief economist of Santander Brazil, Ana Paula Vescovi, revealed in an article titled 'What really affects interest rates in Brazil?, in a newspaper from São Paulo.

To reinforce the "income-concentrating, unfair, and unequal" nature of interest payments, agreeing with Vescovi, it is necessary to emphasize that the amount spent on interest in 2021 was 448 billion reais, a year in which the basic interest rate set by the Central Bank began at its historical minimum of 2% per year and ended at 9,25%. Interest expenses in 2022 are expected to be much higher, since we started the year at 9,25% and quickly reached 10,75%.

These nearly 450 billion reais, more than 5% of the country's Gross Domestic Product, go into the pockets of those who have money in financial investments, the small, wealthiest segment of the population.

To give an idea of ​​the magnitude, note that the projected spending for the Brazil Aid program in 2022, intended to alleviate the hardships of tens of millions of people, is 89 billion reais, or five times less than the amount spent on interest. The amount spent on interest also represents about 12 times the cost of the Bolsa Família program, estimated at 35 billion reais in 2021.

Vescovi classifies this interest expenditure as "uncertain," meaning it's unknown whether this mountain of money, transferred to holders of financial investments, will be effective in achieving its purpose: lowering inflation. And once again, we agree with his assessment. The pricing policies of companies with market power, for example, are not subject to monetary tightening. A brief analysis of the role that fuel prices have played in the current inflationary surge in Brazil should clarify the insubordination of certain industries to monetary policy. Similarly, products traded internationally, which have globally determined demand and prices, are not directly independent of greater or lesser monetary tightening.

The agreement with the economist ends here. To discuss the "difficulty of monetary policy, by itself, controlling inflation, given a significant increase in public debt," Vescovi makes a linear argument: "when fiscal policy doesn't help, the Central Bank loses degrees of freedom to manage the expectations channel, having to swim against the tide: more public spending, more inflation, more interest rates, more debt, less consumption and investment, and less growth."

First of all, it's important to remember that in practice and in economic literature there are many other ways to combat inflation. It is neither necessary nor essential that the only instrument be raising interest rates. The cost/benefit of treating inflation exclusively with interest rates has been widely questioned. The 1981 disaster, orchestrated by Paul Volcker with the increase of short-term interest rates to 20% per year, is a good illustration.

As he says Dani RodrikAccording to Hrvard, economics is not a science of fixed rules. For him, the current inflationary pressure stems from transitory causes and, therefore, the reaction should not be exaggerated: "orthodox remedies for inflation often have costly side effects, such as bankruptcies and increased unemployment, and do not always produce the desired effects quickly enough."

Secondly, inflation often has no direct relationship with greater or lesser fiscal balance. An increase in public spending can mean more inflation, or it may have no influence on prices. The main example is the crisis that originated in the US housing market in 2007/2008 and spread worldwide. The Fed and the US government flooded the economy with dollars without any result on inflation.

Regarding the discussion about current inflation, James K. Galbraith, former director of the US Congressional Economics Committee, argues that:

“The stated reason for tightening monetary policy is to combat inflation. But interest rate hikes will do nothing to counteract inflation in the short term and will work against price increases in the long term, only provoking another economic collapse. Behind the policy lies a mysterious theory that links interest rates to the money supply and the money supply to the price level. This 'monetarist' theory is not stated today for a good reason: it was largely abandoned 40 years ago after contributing to a financial disaster.”

Galbraith's thesis is that the Fed's true target, when raising interest rates, is the wages of those working in the service sector. He argues that since energy prices and the prices of most products are set globally, the only prices that the Fed's policy can affect are those of services, as these are not tradable outside the country's borders. The result of raising interest rates will therefore be the compression of wages in this sector, he concludes.

Thirdly, lower government spending, lower inflation, and lower interest rates do not always result in higher investment and consumption. Monetary stability without the expectation of job security curbs household consumption, and without the prospect of increasing sales, it reduces investment. Almost 100 years ago, Keynes already stated that there are suboptimal equilibria, below full employment.

Fourth, controlling inflation cannot be the ultimate goal of economic policy. The most important economic variable is employment. In the US, for example, since 1977, the Fed's mandate has been twofold: "to maintain long-term growth of monetary and credit aggregates consistent with the economy's long-term potential to increase output, so as to effectively promote the objectives of maximum employment, stable prices, and moderate long-run interest rates."

Recently, the Nobel Prize Joseph Stiglitz He also revealed that his biggest concern regarding inflation and interest rates is that central banks might overreact, excessively raising interest rates and thus restricting a nascent recovery. And in this scenario, he continues, people with the lowest wages will be the ones who suffer the most, as always.

Their argument is based on the US unemployment rate, which is significantly lower than Brazil's. Therefore, it is even more reasonable to reject the path taken by our independent central bank. We are leagues away from full employment and administering massive doses of the typical remedy for demand-pull inflation, worried, as the Santander economist states, "whether Brazil will sanction a less predictable fiscal adjustment process," or worried whether we will bring down the spending cap that should never have been created.

A Copom minutesFollowing the 150 basis point increase in early February, raising the Selic target rate to 10,75%, the government states: "Without prejudice to its fundamental objective of ensuring price stability, this decision also implies smoothing fluctuations in the level of economic activity and promoting full employment."

One in four people in the country's workforce is underemployed. That's 29,1 million underemployed people in Brazil. And the Central Bank explains that higher interest rates promote full employment. Is that really the case?