MNI INTERVIEW: Brazil Potential GDP Explains Stronger Activity

A new methodology developed by the Finance Ministry found Brazil’s potential GDP at 2.6% last year, above the 2.4% estimated by the traditional model, helping to explain why economic activity has been surprising to the upside without triggering proportional inflationary pressure, Secretary for Economic Policy Guilherme Mello told MNI.

A higher potential GDP could allow for a more accommodative monetary stance over time, Mello said in an interview. (See MNI INTERVIEW: BCB To Start Cuts In January - Figueiredo)

The ministry’s estimate is above those used by the central bank and other institutions, which range between 2.1% and 2.3%. Traditional methodologies rely on capital and labor in the production function, while the new model incorporates electricity generation capacity and arable land, with plans to include hydrocarbon and biofuel production capacity in the future. 

“This new methodology reduces the size of the residuals, of things that influence structural growth but are not explained by capital or labor,” Mello said. “The idea is to foster the debate to incorporate these innovations that we brought in our study,” he added, noting that similar approaches have been adopted in other countries but are only just being applied to Brazil for the first time.

GROWING ABOVE POTENTIAL

Even under the new methodology, Brazil’s GDP grew well above its potential in 2024, expanding 3.4%. 

A higher potential GDP would allow monetary policy to be adjusted in a way that supports stronger growth while still closing the output gap ahead, Mello said. “It’s very different monetary policy stances (with lower and higher potential GDP).”

The official recalled that, some time ago, market participants would have expected inflation to reach around 10% if GDP grew 3% and unemployment averaged 6%. "That’s not what we have seen now,” he noted. Brazilian inflation was 4.68% in October.

The central bank uses several methodologies, undersecretary Raquel Nadal explained. “BCB doesn’t disclose how it calculates, so, from what I understand, it uses different ways of calculating and takes an average, which is what it presents,” she said.

“Our intention was precisely to open this black box and show what we are doing to arrive at this number,” she added. The ministry intends to publish an updated figure annually and, later on, is expected to release a projection of future potential GDP as well.