Brazilians will head to the polls on Oct. 5 to vote in a tight presidential race. President Dilma Rousseff’s leading challenger is Socialist Party candidate Marina Silva. A key component of Silva’s economic platform is her support for a more independent central bank. Central bank independence, long a topic of interest to economists, is now capturing wide public attention — and for good reason.
Central banks across the world face different sets of laws regarding their governance structures, their autonomy, and the scope of their powers and responsibilities. In the last two decades, many countries have passed laws granting their central banks legal independence from government. Without central bank independence, inflation can be undesirably high for two main reasons.
First, a government-controlled central bank might use monetary expansion to inflate away nominal liabilities such as government debt. Second, monetary expansion may be used to boost short-run growth for the sake of political popularity prior to elections. Central bank independence laws are intended to allow central bankers to focus on objectives like price stability without interference or pressure from the government.
Currently, Brazil’s central bank is not legally independent. The central bank president has no fixed term length and can be fired by the Brazilian president. President Rousseff and Silva debated the issue of central bank independence on September 1. Silva proposes increasing the central bank’s independence, for example by giving the central bank president a fixed term as a form of insulation from political pressure.
What could a more independent central bank mean for the Brazilian economy? Brazil’s central bank practices inflation targeting, a monetary policy framework that was adopted by many countries in the 1990s in an effort to bring down high inflation. An inflation targeting central bank announces a specific quantitative goal for inflation and uses monetary policy to keep inflation near the target. In Brazil, the inflation target is 4.5 percent, with a 2 percent window on either side. Thus the bank’s goal is to keep inflation between 2.5 and 6.5 percent.
Inflation in Brazil has hovered around 6.5 percent since 2008. A legally independent central bank would likely have pursued tighter monetary policy — namely, higher interest rates — to keep inflation nearer to the 4.5 percent target. Economic growth in Brazil has been fairly slow for the past decade, especially since 2011. Growth in the gross domestic product (GDP) was negative in the first and second quarters of 2014. Tighter monetary policy would further slow GDP growth, the last thing an incumbent wants near an election. Without legal independence, the bank has faced pressure not to raise interest rates as high as they otherwise might have.
Tighter monetary policy would, temporarily, be bad for the Brazilian economy. But a central bank with the independence to pursue the inflation target without interference could help in the long run. Monetary policy can help smooth fluctuations in the business cycle, but it is not the solution to low growth that arises for structural reasons. Allowing inflation to reach the upper limit of the bank’s tolerance interval for a short period to avoid a recession is perfectly suitable, but Brazilian economic growth has been weak, and inflation has been near the top of the tolerance interval for many years now. Such long-term stagnation needs to be addressed with deeper economic reforms, not with monetary policy. But reform is hard, and when policymakers hold sway over the central bank, they will naturally want to use it as a short-run solution to long-run problems.
President Rousseff argues that granting more independence to the central bank would pose a threat to financial stability. I don’t think that is the case. The biggest threats to Brazil’s financial stability arise from the same structural problems that result in its stagnant growth. As Professor João Saboia discussed at a CLAS seminar on September 10, economic reforms to improve labor productivity, such as improvements to the education system, are crucial for Brazil’s longer run macroeconomic prospects.
According to economists N. Nergiz Dincer and Barry Eichengreen, who have constructed indices of central-bank independence for 89 countries, Chile has the most independent central bank in Latin America. Legislation granting independence to the Chilean Central Bank was passed in 1989. The Central Bank of Chile, like that of Brazil, is an inflation targeting central bank. Chile’s inflation target is 3 percent with a 1 percent tolerance window on either side. Chile has both a legally independent central bank and one of the most stable economies in the region and has maintained higher growth, lower inflation, and lower interest rates than Brazil in recent years. Clearly, central bank independence needn’t threaten financial stability or macroeconomic performance, provided an appropriate set of economic and political institutions are in place.
While President Rousseff and Ms. Silva differ in opinion on central-bank independence, there is one aspect of Brazilian economic policy that both support — Bolsa Familia. Bolsa Familia is an anti-poverty program that provides cash transfers to a quarter of the Brazilian population. To receive these payments, families must keep their children in school and vaccinated.
The program, launched by former President Luiz Inacio Lula da Silva in 2003, is widely acclaimed for its cost-effectiveness and for keeping more children in school instead of at work. Bolsa Familia seems very likely to remain in place, but other components of Brazilian economic policy will depend critically on the outcome of the election.