The contribution of the Central Bank to this transition has been a more expansionary monetary policy that has smoothed the cycle and supported the depreciation of our currency, within a flexible exchange rate scheme. Although such depreciation has transitorily increased inflation, it has aided the necessary resource allocation across sectors. All this has occurred in a context where inflation expectations and monetary policy credibility have remained intact. As I mentioned, this Report’s baseline scenario foresees inflation declining further, to converge to 3% somewhat sooner than we thought in June. This assumption estimates that, in the short term, the exchange rate will remain around its levels prevailing at the last statistical cutoff date. But of course, there are significant degrees of uncertainty, so the risks are still there. One of our concerns in June regarding the external scenario was the so-called Brexit. However, and quite unexpectedly, its approval increased the markets’ perception that the developed world’s monetary policies would stay highly expansionary for a longer period of time, driving global financial conditions, particularly those facing the emerging world, to be more favorable than we assumed in the first half of the year. Despite a partial reversal in recent weeks, the mood of the markets is better than anticipated, even considering that the Federal Reserve is expected to raise its monetary policy interest rate again. Services inflation—typically associated with non-tradables—has not changed much and is expected to continue decelerating gradually.
This is the main reason for the expansionary nature of our policy making in recent years, even with inflation being persistently above the target range. Keep in mind that the fiscal rule determines a generally acyclical public expenditure, meaning that it runs independent from the business cycle. Why? Because fiscal policy is typically slow to react and any change in spending decisions are much more difficult to undo. Thus, monetary policy is essential to deal with the economy’s cyclical fluctuations. That explains our actions. Since late 2013 we have implemented a clearly expansionary monetary policy, indeed one of the most expansionary among emerging market economies. Real short-term interest rates have been negative or barely above zero for all this time, helping medium- and long-term rates to be nearly as low as they have ever been. This policy has not only helped the economy to adjust smoothly by providing support to aggregate demand; by letting the exchange rate move freely it has also contributed to the adjustment of relative prices—a key element to address in these conjunctures. The contrast with other episodes is evident. Suffice it to recall the costs associated with the defense of the exchange rate in the early 1980s and, to a lesser extent, during the Asian crisis and its aftershocks in the late 1990s.