Oil prices and inflation in Brazil: exchange rate versus inflation targeting CLAUDIO A . C . PAIVA
This chapter examines the relationship between oil prices and inflation in Brazil during 1994-2008. The period is particularly rich from a research standpoint because it spanned two very distinct periods of monetary policy strategy: the exchange rate targeting (ERT) carried out in 1994-1998 and the inflation targeting framework (IT) adopted in 1999. Therefore, besides providing an estimate of the overall impact of oil prices on inflation in Brazil, this chapter also investigates whether this impact has changed after the adoption of IT. In addition, interesting byproducts of the empirical work include estimates of the degree of persistence of inflationary shocks and the impact of economic activity, the exchange rate, and the interest rate on inflation under the alternative monetary regimes. The empirical investigation relies mainly on estimates of VARs and their associated impulse response functions. Different model specifications generally include a measure of consumer prices, domestic wholesale fuel prices, the nominal exchange rate between the Brazilian real (BRL) and the US dollar (USD), a measure of economic activity, and a measure of interest rates. In addition, single equations provide estimates of the pass-through from international oil prices and the exchange rate to domestic fuel prices. The data set comprised quarterly data spanning the period 1994:3-2008:2. Empirical estimates suggest that although the pass-through from the cost of oil to domestic fuel prices has increased, the impact of fuel prices on inflation in Brazil has declined under IT. This result is in line with international evidence that an increase in the forward looking component of inflation expectations and in the credibility of monetary policy has reduced the inflationary impact of higher fuel prices in recent years.1 Anecdotal evidence of this change in price dynamics includes the relatively small response of inflation in Brazil and in industrial countries following the surge in oil prices (and other commodities) since 2003. This recent experience contrasts with the widespread acceleration of inflation following the oil shocks of the 1970s.