When it comes to inflation, the first thing that invariably comes to mind is the Political Economy 1 course I did many years ago. It was the first exam and I discovered what inflation really is: a tax that the state imposes on citizens.

And it is a cruel tax, because it is not progressive, it does not distinguish between rich and poor: on the contrary, it affects those who cannot “get rid” of the currency that is rapidly losing its value.

Hyperinflation has destroyed democracies, caused poverty; for this reason the control of the value of money is one of the priorities of the state. In Brazil, the institution responsible for this purpose is Banco Central, which has recently acquired greater autonomy in the management of the monetary base and interest rates.

After the introduction of the “real” in 1994, Brazil gave relative stability to the value of its currency and controlled inflation. During the economic crisis of 2015-2016, inflation exceeded 10% but was quickly brought back towards the center of the Banco Central thanks also to a sharp increase in the discount rate (SELIC).

But everything changed after the outbreak of the coronavirus pandemic.

To stimulate the economy, Banco Central, from March to June 2020, brought the already low discount rate (SELIC) from 3.75% per year to 2.25% per year.

One of the first economic consequences was the strong appreciation of the dollar against the real: in February 2020 R $ 4.25 was enough to buy one dollar, at the end of May it needed 5.52.

This shock had immediate consequences on inflation calculated through the IGP-M index (General Market Price Index, detected by Fundaçao Getulio Vargas), well known in Brazil for being used in rental contracts. The IGP-M index measures the change in prices for producers, consumers and in the construction sector.

As can be seen from the graph above, in a few months the inflation measured by this index has exploded and today is equal to 31% on an annual basis.

Different speech, however, with regard to the IPCA (Wide Consumer Price Index), detected by the IBGE and officially used by Banco Central.

Producers of goods and services saw costs rise at the same time as demand collapsed, which is why they could not immediately raise consumer prices.

This anomaly has led to a drastic reduction in profit margins, putting the very survival of many companies at risk.

Without visible signs of a recovery in inflation measured by the IPCA index, in August 2020 Banco Central brought the discount rate to 2%, keeping it at this historic low until February 2021.

The result? A further devaluation of the real (the dollar in November reached a price close to R$ 5.80) and rising inflation.

The inflation index of the last 12 months (IPCA) reached 6.10% in March 2021 and Banco Central has finally decided to intervene, increasing the SELIC from 2 to 2.75% and announcing a new increase of 0, 75% in May 2021.

Banco Central, let us remember, has as its main objective the defense and maintenance of purchasing power on the internal market of the national currency, the real. Maintaining a certain exchange rate, or the value of the real at an international level, is not a goal of Banco Central, which intervenes on the exchange only when it becomes a threat to inflation.

In recent months, Banco Central has intervened a few times to stop the devaluation of the real, limiting itself to selling dollars in moments of greatest market stress. Its main “weapon” remains the determination of the discount rate (SELIC), the increase of which determines on the one hand a greater attractiveness of Brazilian bonds (also internationally) and on the other hand a greater burden of maintaining the public debt of the State.

In a time of fiscal crisis caused by the pandemic (simplifying, higher expenses in the face of lower revenues), raising interest rates to attract investors can only aggravate the cost of debt.

To get out of this “impasse” and avoid an implosion of the economy, the need for structural interventions that change the composition of the state’s income and expenditure has been discussed for some time. These are the long-awaited reforms, first of all the administrative and tax reforms.

The reforms are in progress in Parliament, but to be able to approve them in a version that can really make the state mechanism more balanced (and equitable), a political will and a sense of responsibility are needed, which at the moment seem to be lacking.

The pandemic will pass, but its disastrous effects on the economy will be felt for a long time. It is up to those who govern Brazil to make the right, albeit painful, choices to get out of the crisis.

 Rebalancing public finances and curbing inflation are two fundamental prerequisites for sustainable growth in Brazil.