Is the Investment-Uncertainty Link Really Elusive? The Harmful Effects of Inflation Uncertainty in Brazil

After being one the fastest growing countries in the world during the 1940-80 period, with an average growth rate of 6.8%, Brazil has experienced a severe growth slowdown since the 1980s, which coincided with the steep rise in inflation as of 1980. At the same time, real investment rates have plunged, shrinking around nine percentage points just in the 1980s. Moreover, they were unable to recover their 1989 level afterwards. This is unexpected as several pro-growth reforms took place since 1990, such as trade liberalization, privatization and economic stabilization. More strikingly, in the ten years following the stabilization of the economy, real investment rates have being at their lowest levels for, at least, fifty years. One major factor that could help explaining this dismal behavior is inflation uncertainty, which have remained high despite much lower inflation since 1994. Indeed, inflation uncertainty is at the root as many types of uncertainties faced by firms. For example, it also means uncertainty about future interest rates and demand. This work aims both at uncovering the main determinants that have driven M&E investment in Brazil since 1980 and testing the link between inflation uncertainty and investment. The evidence strongly suggests that inflation uncertainty has been an important investment deterrent in Brazil, both in the short and long runs. Moreover, its effects were found to be asymmetric. Also, despite the limited role played by price variables in empirical studies of investment, the real interest rate, itself importantly affected by inflation uncertainty and inflation risk premium, seems to be another key factor in explaining low investment rates in Brazil.

Is there too much certainty when measuring uncertainty

This paper criticises the econometric inflation uncertainty proxies found in the literature, which show an overly optimistic picture about our real ability to forecast, and highlights the sharp contrast between the evidence portrayed by that literature and the evidence conveyed by the literature on surveys of inflation expectations. While the latter shows that actual forecasts are usually biased and systematic forecast errors are pervasive the former shows a much more optimistic picture, in accordance with the rational expectations paradigm. Also, both literatures have historically shown conflicting evidence on the inflation level – inflation uncertainty link. Next, the performance of inflation forecasts from both the Central Bank of Brazil Inflation Report and the Focus Survey are analysed. The paper then pinpoints some simple measures that could be taken to improve the reliability of econometric inflation uncertainty proxies, and carries out a (pseudo) real-time forecasting simulation exercise to derive a set of such proxies for Brazil. The features of those forecasts are shown to be very similar to those found in surveys.inflation level, inflation uncertainty, in-sample forecasts, out-of-sample forecasts, temporal inconsistency, forecast failure, surveys of expectations, rationality

Are Core Inflation Directional Forecasts Informative?

Core inflation is under attack. Empirically, experts have become increasingly disappointed with its actual performance. Theoretically, while some claim that it is a key inflation predictor others argue that, by construction, that cannot be one of its main properties, at least in the short run. Even if true, core inflation could still be useful if it provides good directional inflation forecasts. The evidence presented here using U.S., Canadian and Brazilian data shows that this does not seem to be the case. Directional forecasts are often no better than a coin toss, especially from the level model. The gap model’s forecasts are wrong, on average, at least 20% of the time. More crucially, they are usually no better than a simple moving average of headline inflation.

Estimating Brazilian Potential Output: A Production Function Approach

Estimating potential output is at the same time one of the issues of greatest uncertainty in economics and greatest importance for policymakers, an unpleasant combination. This uncertainty fostered the emergence of several methods for calculating the potential output. In this work, the production function approach was chosen because it has important advantages compared to others, although it has limitations. The preliminary results found for the Brazilian economy are the following: a) total factor productivity (TFP) decreased in the last two decades, however, the negative trend was reverted after 1992 and, since then, TFP has been growing, on average, 0,9% per year; b) since 1980, most of the time the Brazilian economy has been below its potential. The years with strongest activity were 1980, 1985 and 1986; c) simulations involving different scenarios for investment and TFP growth rates, show that the average potential output growth for the 2001-05 period should be between 3,3% and 4,5%; d) although these figures are much lower than those registered before 1980, they are higher than the average GDP growth in the last two decades; e) because of the deep structural changes the Brazilian economy has been experiencing recently, we can expect TFP growth to increase in the next years. Even so, without increasing investment rates significantly, Brazil will not grow at rates near to its historical average.

The Natural Rate of Unemployment in Brazil, Chile, Colombia and Venezuela: some results and challenges

This paper summarises the research results obtained by the group of central banks (Brazil, Chile, Colombia and Venezuela) that joined the research program on the Natural Rate of Unemployment – under the coordination of the Central Bank of Brazil – within the Joint Investigation on Non Observable Variables Project, and whose final results were presented at the XII Meeting of the Network of America Central Bank Researchers (CEMLA) held at Madrid in November 2007. The evidence obtained shows that the natural rate of unemployment is estimated with great uncertainty: besides sizable parameter uncertainty, estimates are very sensitive to the particular method used. This marked imprecision reflects the difficulties and challenges involved in the natural rate’s estimation. Nonetheless, the research also shows that there seems to be much room available for improvement, especially those stemming from a more careful modelling process and better care with the data, particularly regarding supply shocks proxies, given their importance in inflation dynamics. Indeed, this “channel” seems to be the most promising one to both narrow down the uncertainty about the NAIRU and improve the reliability of inferences.

An Operational Definition of Price Stability

The attitude towards inflation has changed thoroughly along the last decade. The change was basically motivated by three reasons: a) the high cost resulting from the inflation increase in the 70s and 80s; b) the lower than expected costs of the global disinflation in the 90s; and c) the significant evolution of the literature on inflation costs and benefits in the past ten years. Indeed, today it is known that inflation costs are very much higher than the estimated at the beginning of the 90s. This difference is partially due to the better identification and measurement of costs produced by the perverse interaction between inflation and tax system. On the other hand, some arguments in favor of 'some' inflation has come up in this period. And, in spite of difficulties in the estimation of some of the specific inflation costs, there is a consensus today that the main objective of the monetary policy must be price stability. However, literature improvements have not been enough to establish which long-term inflation rate should be targeted or which is the optimal inflation rate. This paper aims at showing, summarily, the main inflation costs and benefits considering the recent advances in the specialized literature. The intention is to contribute to the discussion about what should be the long-term nflation target for Brazil.

Searching for the Natural Rate of Unemployment in a Large Relative Price Shocks' Economy: the Brazilian Case

This paper contributes to fill the large existing gap in the literature on the Brazilian natural rate of unemployment. It reveals not only that the correlation between inflation and unemployment has changed radically since the stabilisation of the economy but, more surprisingly, that it has become positive in the recent past. In other words, there has apparently been no trade-off between inflation and unemployment. However, this fact is due to – and highlights – the paramount importance of supply shocks in recent inflation dynamics in Brazil. The paper then shows that the exchange rate has been the major source of shocks to inflation, even though it is not enough to explain the magnitude and persistence of those shocks. Part of the answer comes from the large and wide effects produced by privatisation on the price dynamics in Brazil. The evidence presented here suggests that the Brazilian natural rate of unemployment has been constant since 1996. Despite the high degree of uncertainty involved in natural rate estimations, point estimates seem to lie somewhere between the 7.4%–8.5% range. The paper also sheds light on why real interest rates have been so high for extended periods of time in Brazil, a feature that has puzzled many economists. Finally, it calls to attention that one important core inflation measure in Brazil has not been able to capture underlying inflation properly and, therefore, has to be used with caution.

Has core inflation been doing a good job in Brazil?

This paper assesses the performance of the core inflation measures calculated by the Brazilian Central Bank (BCB). The evidence shows that they do not meet some key statistical criteria that a good core inflation should have: unbiasedness and the ability to forecast inflation. That performance stems, to a large extent, from the lack of a well-grounded statistical and economical basis behind them. Three new measures are built and assessed using the same criteria. The evidence shows that their behaviour is more in accordance to what the theory claims. However, they still lack the ability to help forecasting inflation. Hence both the BCB and the market should use core inflation cautiously.Core inflation; inflation; supply shocks; relative prices; volatility

Is there too much certainty when measuring uncertainty

This paper criticises the econometric inflation uncertainty proxies found in the literature, which show an overly optimistic picture about our real ability to forecast, and highlights the sharp contrast between the evidence portrayed by that literature and the evidence conveyed by the literature on surveys of inflation expectations. While the latter shows that actual forecasts are usually biased and systematic forecast errors are pervasive the former shows a much more optimistic picture, in accordance with the rational expectations paradigm. Also, both literatures have historically shown conflicting evidence on the inflation level – inflation uncertainty link. Next, the performance of inflation forecasts from both the Central Bank of Brazil Inflation Report and the Focus Survey are analysed. The paper then pinpoints some simple measures that could be taken to improve the reliability of econometric inflation uncertainty proxies, and carries out a (pseudo) real-time forecasting simulation exercise to derive a set of such proxies for Brazil. The features of those forecasts are shown to be very similar to those found in surveys

Is there too much certainty when measuring uncertainty

This paper criticises the econometric inflation uncertainty proxies found in the literature, which show an overly optimistic picture about our real ability to forecast, and highlights the sharp contrast between the evidence portrayed by that literature and the evidence conveyed by the literature on surveys of inflation expectations. While the latter shows that actual forecasts are usually biased and systematic forecast errors are pervasive the former shows a much more optimistic picture, in accordance with the rational expectations paradigm. Also, both literatures have historically shown conflicting evidence on the inflation level – inflation uncertainty link. Next, the performance of inflation forecasts from both the Central Bank of Brazil Inflation Report and the Focus Survey are analysed. The paper then pinpoints some simple measures that could be taken to improve the reliability of econometric inflation uncertainty proxies, and carries out a (pseudo) real-time forecasting simulation exercise to derive a set of such proxies for Brazil. The features of those forecasts are shown to be very similar to those found in surveys