Inflation Targeting in Brazil: Shocks, Backward-Looking Prices, and IMF Conditionality

This paper examines the recent evolution of monetary policy since the adoption of formal inflation targeting in Brazil. We argue that the new policy framework has been subject to a severe test in its first years of existence, represented by external shocks - oil prices, and increased international financial volatility. Moreover, we examine some selected issues that deserve due consideration given their importance to the conduct of monetary policy. The first issue is the presence of a substantial portion of prices with backward-looking adjustment, a fact that affects monetary policy reaction since it reduces the efficiency of domestic interest rates in controlling inflation. The second addresses the question of how inflation targets should be monitored in a country that has an ongoing economic program with the International Monetary Fund. This last issue is particularly important when considering the effects of shortening monitoring horizons on the variability of inflation and output.