A “soft landing” is the difficult and often elusive feat of successfully lowering inflation after having tightened monetary policy, but without triggering a recession. When fighting inflation, policy makers raise interest rates to make credit more expensive. This dampens aggregate demand and takes some of the inflationary steam out of the economy. The challenge is not take-out more “steam” than is necessary and inadvertently induce a recession. It’s an outcome that requires skillful policy making and economic resilience, aided by the absence of adverse shocks.
Is Brazil heading in this direction? Inflation, now at 4% has come a long way down from its peak at 12% in April 2022. The latest labor market figures placed unemployment at 8% by June of this year, the lowest it has been since 2015. The number of underemployed (individuals working less than 40 hours a week) has also declined over the past year. These trends have prompted economic analysts to upgrade growth forecasts and lower risk ratings during the course of the year. Importantly, they provided the conditions for a shift in the monetary policy cycle, with a 50 basis point reduction in the SELIC in July, pointing to start of a cautious monetary policy easing cycle.
What helped Brazil reach this point? A strong harvest offered a cushion against slowing commodity prices, contributing to a stronger trade balance (the trade balance in June 2023 was up by 18% compared to the previous year). Household consumption, although dented by inflation, has been somewhat cushioned by a robust job market and transfers to vulnerable households.
Other factors are of a more institutional nature. A more flexible labor market supported a rapid recovery in job numbers as the pandemic eased, allowing the labor force to return to various forms of work in a context of high uncertainty. Prudent management of public finances, even as the country adapted and debated the form of its fiscal rules, was a source of macroeconomic stability (the primary balance stood at -0.24% in June 2023, almost 10 percentage points below its peak in 2020). And critically, Brazil’s early and credible monetary policy response to inflation would have been weaker in the absence of an independent and competent central bank.
These indicators provoke a sigh of relief , but it’s not all good news. The outlook also holds a set of important risks that could create turbulence along the way. Monetary policy is still tight, and it takes effect with a delay, meaning that its full impact on economic activity and jobs may not have been felt yet. Indeed, the recent signs of cooling in the pace of the labor market recovery (net formal job creation in the first half of 2023 was 26% below the same period last year) underlines the need to carefully manage this risk.
On the global front, a softening commodity price outlook and slowing momentum in global growth, including amongst some of Brazil’s main trading partners, can make for more challenging conditions. The El Nino weather phenomenon adds further potential obstacles. Problems of a more structural nature, the low-productivity economic model that has underpinned Brazil’s lackluster economic performance over the past two decades in particular, traps the country in a low growth scenario and limits its ability to confront shocks.
Cautious macroeconomic policy making will be essential to tackle remaining inflationary pressures, especially any remaining momentum in core prices, whilst also rebuilding fiscal buffers. But equally as important is advancing the structural reforms that have long eluded this economy. The indirect tax reform is a priority among them; securing this critical reform will help boost confidence and investment in the economy at a time when tailwinds might be receding. Also essential is shifting to a policy mix that stimulates competitiveness and job creation through greater competition in markets, deeper trade integration and by stimulating technological adoption. This will offer policy makers an alternative to the unproductive mix of tax incentives and “wars”.
Such measures would not only make a soft landing more likely but would also build a longer and smoother landing strip to soften the landings for future shocks.
