Roberto Macedo: Not at all. I have been saying for some time that the economy was in a bad state. Interest rates are too high and will not be falling to reasonable levels in the near future, and the exchange rate is overvalued. A combination like this is bound to lead to lower GDP growth. Moreover, the political crisis also damaged consumer confidence. 

Macedo: The inflation targeting system is not as effective in Brazil as in other countries, with the result that interest rates are too high to control inflation. Moreover, the targeting  system is not yet scientifically sound as there's no undisputable evidence that it has worked successfully both in developed and in emerging countries. It is relatively new and started in New Zealand in 1990. Inflation has been brought down in countries which use the system but that's not just because of the targeting system. Inflation is a complex thing.

We in Brazil are frightened of inflation because of our past experience when we had decades of high inflation and almost hyperinflation. In March 1990 it came to 84% in one month. If you adapt a policy of inflation targeting then you have to make it suitable to conditions in Brazil and not just impose it as being 100% effective, as the Central Bank seems to think you can. Look at the exchange rate, for example. If inflation is caused by the exchange rate effects then interest rates will only control the secondary effects, not the primary ones. The Brazilian economy is also very sensitive to the price of commodities, especially grains, gasoline and diesel oil, and the inflation targeting system is not an effective way of dealing with this aspect.

At the same time, its application in Brazil is inconsistent with the credit policy, as the government has extended credit in various ways, including consignment loans from the worker's pay packets. This means that, on one hand, you're holding the brake down with interest rates, but on the other you're accelerating by expanding credit. Again you have to skyrocket the basic interest rate to have good results in the inflation front, but then you do great damage to GDP. An additional point is that the government has a major part of its debt indexed to the interest rate set by the Central Bank. When interest rates are increased the debt goes up and investors have income gains that add to demand pressures. How can you rely on a naïve inflation targeting system under these conditions?

Macedo: Every effort should be made to fight inflation but we should not leave the Central Bank to cope with this heavy burden alone.  We should take into account other factors like the monetary aggregates, such as M1, M2 and others.  In the past, these used to be the main anti-inflation tools but were entirely abandoned. However, they cannot be ignored, as the Central Bank has done. We should also look at administered prices which are index-linked, such as electricity and telephone services, and also consider the role of monopolies and cartels, and the concentration of economic power in general. For example, there have been recent reports of a cartel fixing prices in the meat sector. This is the kind of behavior that pushes up prices. If there is no structural reason behind price rises then you should attack the causes. I'm not calling for price controls but identifying where the problem is. External tariffs are another instrument. If the price rises, you reduce the tariffs. And last, but not least, the credit and fiscal policies have to be consistent with the monetary policy and this is not happening. I also see problems on the side of the so-called incomes policy, as the minimum wage has been rising above productivity. All these alternatives are available but the Central Bank has been left alone to fight higher prices using only a simplistic version of inflation targeting.

Macedo: I know that if interest rates become too low then investors will take their money from government bonds and might even leave the country but this would a problem for the Treasury, not the Central Bank. I am not suggesting an immediate sharp cut in the interest rate. It should come in steps and be in parallel and consistent with other anti-inflationary policies, as we have suggested earlier in this interview.

Macedo: I'm very concerned about inflation but the current system is not effective. It is inconsistent with other policies and, as it exaggerates the rise in the exchange rate, it is causing a serious damage to growth. Growth in 2005 will be less than 3% - perhaps 2.5% - and anything below 5% is no good at all.

Macedo: Close to 5% a year and never above 10%. In Brazil, a two digit inflation would be very dangerous as it would bring a strong pressure to resume widespread indexation. In the seventies we thought, along with Milton Friedman, that indexation would mitigate the inflation effects but we have learned that this was not the case.  One of the reasons is that indexation requires inflation indices that take at least one month to be calculated. Therefore, when inflation is rising, indexation always falls behind.  Moreover, an index is an average and indexation does not adjust all prices in the same fashion, thus causing distortions in the price system.

Macedo: If I was not optimistic I would have left Brazil a long time ago. The macroeconomic side is not doing well but the microeconomic area is a different story and things are moving ahead. Whereas macroeconomic matters take a long time to resolve in a democracy, the microeconomic side is a lot more dynamic. Although I am an economist and made an academic career and served in the Finance Ministry as Secretary for Economic Policy, afterwards I also spent a lot of time working with businessmen, as president of two trade associations. Businessmen see the economy differently. They don't look at the GDP figures but at the market. I also look at the Brazilian economy as a market and, while I do not see a general boom, I see a boom in various regions, sectors and industries.

Macedo: Look at cosmetics and beauty products. Sales of cosmetics are expected to increase again by close to 20% in 2005. Avon has one million saleswomen in Brazil. Natura, a young Brazilian cosmetic company, has close to 500,000 saleswomen. Natura is trading on the stock exchange and even expanding abroad. Casas Bahia, which sells electronic goods and household appliances on credit to the lower income section of the population, has 18 million customers and is opening new shops all the time. Casas Bahia has been so successful that it became a case study at an American business school. Look how Walmart is expanding in Brazil. In regional terms, the MidWest is undergoing the kind of boom the US West experienced in the 19th century, due to the growth of agricultural products like soybeans and cattle. Exports in general and various services, including private education, are also booming.

Part of the microeconomic action happens in the informal sector and some businessmen complain that these street traders do not pay taxes. However, this is not entirely true. In some sectors, like beer and LPG gas, the major taxes are paid at source by the brewers or Petrobras so the government is not losing out at all. It is true that street traders and people in the informal economy do not pay income tax but most taxation in Brazil falls on sales not on income. The genuine tax evasion in informal markets occurs in contraband goods. This is indeed a problem, but not the major one in terms of tax evasion.

It should not be forgotten that Brazil is a huge market with 185 million people and medium-sized average income by international standards. All the major multinational companies are here and new ones, from Korea for example, have been among the new arrivals.  The attraction is always the market, and it remains attractive in spite of the grey macroeconomic picture

Macedo: I think it will be difficult to bridge the wage gap in the short term but I am betting that demographic trends will bring extremely positive results. The fertility rate has fallen to 2.1 per woman in their reproductive years and this means fewer children will reach the public education system in the coming years. This will reduce the need for new schools and more resources can be directed to improving the quality of education. At the same time, it will not be so difficult as today to find jobs for the young people when they reach working age.

The picture will be brighter if we can resume growth at higher rates, as this will further increase the income level and reduce the number of poor people.

I would sum up by saying that while the macroeconomic area is grey, the microeconomic scene and the demographic trend are bright.

© John Fitzpatrick 2006