Author: Camila Magalhães, economist graduated from IE-UFRJ, master’s degree in Economics from the University of São Paulo and with MBA from SDA Bocconi. She has worked in the public and private sector as a researcher in the macroeconomic area, sectoral analysis and strategy.
Even before the interview of the current Secretary of Finance and Planning of the State of Sao Paulo, Henrique Meirelles, to the BBC Brasil last week, many people had already wondered: why the government does not finance extraordinary expenses during the pandemic simply by issuing currency?
The reason why governments usually don’t increase their spending through money creation is that, in general, this issue has inflationary effects and little or no effect on production. In other words, greater production capacity depends on variables such as technical progress (for example, technological innovations, managerial and organizational improvements) and the increase in the supply of factors of production (for example, an increase in the supply of labor, capital or raw materials). Therefore, giving people more money, if no measures are taken to increase supply, will lead to higher prices.
But would the issue of money be completely neutral, in the sense that it would have no real effects on the economy? This problem has been the subject of debate in various currents of monetary theory.
The classics of Quantitative Money Theory have concluded that the issue of money has no effect on real variables such as employment and real GDP, in any time horizon.
On the other hand, Keynes, in the Preference for Liquidity Theory, concluded that the currency is not neutral in both the short and long term, i.e. the currency would be able to influence production and also production capacity in some sectors, both in the short and long term.
Among the neoclassicals, Friedman revisited the Quantitative Money Theory, arguing that income could be influenced in the short run by a phenomenon of monetary illusion, but in the long run it would become neutral.
The new classics, however, argue that incomplete information would explain the non-neutrality of money in the short term, but a change in the agents’ expectations would invalidate the effect of money on the real product in the long term.
And the new Keynesians, on the other hand, attribute short-term currency non-neutrality to price and wage rigidity.
What does Meirelles defend?
The former minister says the Brazilian government should increase its expenses to deal with the effects of the new coronavirus crisis both through the collection of funds by the National Treasury (issuance of public debt securities) and through money creation by the Central Bank.
According to Meirelles, a currency issue, even without a counterpart in bonds, would not have inflationary effects because the economy would still enter a recession, a factor that would reduce the amount of money circulating in the economy. In this scenario, the Central Bank would have ample room to expand the monetary base.
How does the issue of currency in Brazil work?
According to the art. 164 of the Federal Constitution, the responsibility for issuing currency is exclusively of the Central Bank.
Each quarter the CB makes a monetary programming balance, predicting the quantity of currency that should be issued following the expected growth path for production, discount rate (Selic), expansion of credit operations and amount of salaries increases.
It is important to note that the Brazilian Federal Constitution prohibits the Central Bank from financing the National Treasury, directly or indirectly, to prevent the public deficit from being financed by currency issuance, thus triggering an inflationary process.
In other words, the Central Bank can issue currency to calibrate the need for means of payment in the economy, but not to finance the Treasury debt.
To conclude, economists are not unanimous about the fact that this is the right time to finance an increase in public spending through the issue of money.
We are experiencing a very atypical scenario, with demand and supply repressed in conjunction with a very low discount rate (the lowest ever since Brasil established an inflationary target), which would confirm a scenario of low inflationary risk.
As a counterpoint, Brazil does not have a currency considered as an international reserve, as the dollar in the United States: for this reason, an issue without counterparts could generate a lack of confidence in the currency and lead to a strong devaluation.
We will continue to follow the discussion.