Worst of all worlds: stagflation has once again become a risk, in Brazil and abroad

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Nothing is so bad it can’t get worse. The popular saying was used by President Jair Bolsonaro last week when talking about dollar and gasoline prices. Because a large group of economists is already betting that what is bad could even get worse: Brazil is at risk of entering a scenario of stagflation, the perverse combination of stagnant economic growth, unemployment and high inflation.

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For now, it’s just a risk. The current scenario is bad, but it doesn’t come close to the 1970s, which had the last official crisis of stagflation globally — paving the way for the “lost decade” and hyperinflation in the 1980s in Brazil. But deteriorating expectations are a reality.

“The current signs are still of recovery, but only because the fall in 2020 was very big. All projections are already going down”, says economist André Biancarelli, director of the Unicamp Institute of Economics.

In addition to inflation around 10%, it is already projected that the Gross Domestic Product (GDP), after falling 0.1% in the second quarter, may be close to zero again in the third. For the year, the median of analysts in the Focus bulletin estimates GDP to rise at around 5%, after falling 4.1% in 2020. For 2022, the projection dropped to 2%, but a number of banks and analysis houses have already are betting on growth of less than 1%.

The term stagflation was coined in 1965, first cited by former British minister Iain Macleod of the Conservative Party. In a speech to Parliament, Mcleod debuted the word in English stagflation. “We now have the worst of both worlds: not just inflation on one side or stagnation on the other, but both together,” he said.

There, one of the first questions to a hitherto traditional position of economic theory was consolidated, namely that there would be no high inflation in a scenario of weak activity. If no one is buying so much for lack of income, how can prices be going up?

Even today, economics manuals still reinforce the existence of a call tradeoff, a choice, between employment and inflation: when unemployment is low, there can be an unwanted increase in inflation.

The problem, for Macleod’s UK or for Brazil in 2021, is that inflation started to appear even with economic activity not as heated as one would like.

In Brazil, with factors such as the water crisis and the high dollar, inflation officially returned to double digits and the country had the worst month of September since 1994, the year in which the Real Plan was launched.

Itens IPCA 15 set@2x 2 Worst of all worlds: stagflation has once again become a risk, in Brazil and abroad Groups with the highest increases until September in the IPCA-15, preview of the inflation measured by the IBGE

Groups with the highest increases until September in the IPCA-15, preview of the inflation measured by the IBGE (Arte/via Flourish/Prime Time Zone)

The expectation for 2022 is that inflation will fall again due to the combination of weak economic activity and high interest rates promoted by the Central Bank – with the Selic rate being able to close the year at more than 8%, after starting 2021 at 2.25% . But a nebulous scenario, and not an impossible one, would be growth close to zero next year and inflation not falling as fast as expected.

One challenge is the exchange rate, one of the main factors responsible for Brazilian inflation. The dollar is expected to stay above 5 reais (or more) in 2022, raising production costs in almost every sector and the price for the consumer.