Brazil’s Central Bank Fights Inflation Alone as Government Keeps Spending

Carolina Racy
Apr 11
5 min read

Updated: Jun 21

By Carolina Racy

São Paulo, Northeastern University

Brazil is facing a challenging macroeconomic scenario in 2025. The federal government is pursuing fiscal expansion, while the central bank is keeping a hawkish approach in its monetary policy.

President Lula’s administration proposed a new income tax reform, increasing tax exemptions for those earning up to R$ 5000 a month and introducing a 10% withholding tax on dividends sent abroad on high-income earners. The plan is to increase progressivity and compensate for lost revenue. Yet, analysts warn that this may discourage foreign investment, especially for multinational companies that already face high effective tax rates in Brazil.

Despite warnings, the government continues a series of fiscal and parafiscal consumption stimulus measures. These include extended credit lines, increased social spending, and proposals to prolong tax benefits to sectors like events and education. Many of these policies are widely seen as attempts to regain popularity ahead of the 2026 election.

The government is showing no major signs of fiscal tightening or a sustainable debt control strategy. This is raising concerns about market instability, inflationary pressure and long-term economic sustainability. In February, Brazil recorded a current account deficit of US$8.7 billion, the worst result for the month since 2014, pushing the 12-month deficit to 3.28% of GDP. Meanwhile, public external debt has reached US$ 350 billion, with growing short-term and long-term obligations. As investor confidence weakens, fears of fiscal irresponsibility are increasing, further exacerbated by the depreciation of the Brazilian real, which continues to add upward pressure on inflation.

In response to the macroeconomic imbalances, the Central Bank of Brazil (BCB) raised the interest rate by 100 bps to 14.25% in March, the highest since 2006. This move came in response to persistent inflationary pressures, with the 2025 inflation forecast holding at 5.65%, well above the 3% target. While the headline inflation, as measured by the IPCA (Extended National Consumer Price Index) decreased from 1.23% in February to 0.64% in March, below expectations. Core inflation also eased, particularly in industrial goods, but services inflation remained sticky. In its statement, the monetary policy committee (Copom) justifies the aggressive rate hike by citing the “de-anchoring” of inflation expectations, fiscal expansion by the government, and increasing structural risks. The message was clear: without fiscal alignment, monetary tightening will need to be deeper and longer-lasting to restore price stability.

On top of domestic pressures, a stronger U.S. dollar and fewer rate cuts ahead by the Fed require even more policy discipline by the Brazilian authorities, adding further urgency to the need for coordinated economic strategy.

These economic pressures are now starting to impact the daily lives of Brazilians, as inflation continues to weaken purchasing power and interest rates remain high. While the administration has increased social spending and expanded tax exemptions to stimulate growth and regain political favor, inflation—especially in food—has disproportionately hurt low-income households, who make up much of Lula’s voter base. Roughly 38% of Brazilians earn up to one minimum wage, and over 50 million rely on Bolsa Família (a government cash transfer program for low-income households). These groups spend more than 40% of their income on basic groceries, making them especially vulnerable to rising food prices. In the past 12 months, meat prices have risen 21.17%, ground coffee 50.35%, and oranges up to 59.56%—all far above the overall inflation rate. These spikes are worsening food insecurity for millions of families.

Additionally, higher interest rates have made credit more expensive and slowed job creation, putting further pressure on household budgets. Meanwhile, government stimulus measures have failed to relieve this burden, and are increasingly viewed as politically motivated rather than economically effective.

A poll released on April 2 shows that President Lula’s approval rating has fallen to its lowest level since the start of his term in January 2023. Disapproval rose from 49% in January to 56% in March, while approval dropped from 47% to 41%.

Disapproval is highest among:

Evangelicals (67%).
Those earning more than five minimum wages (64%).
People with up to a high school education (64%).
Young voters aged 16 to 34 (64%).

Approval outweighs disapproval only among:

Those with up to elementary education (55%).
Those earning up to two minimum wages (52%)
Seniors over 60 years old (50%).

Even among voters who supported Lula in the second round of the 2022 election, approval has dropped.

If the government fails to rebalance its economic strategy through stronger fiscal discipline and better coordination with monetary policy, it risks not only prolonged instability but also its political future ahead of the elections.

Key Terms

Fiscal Policy: the use of government spending and taxation to influence a country's economic activity. Expansionary policy boosts growth through increased spending or tax cuts. Tightening (or contractionary policy) reduces spending or raises taxes to contain inflation.
Monetary Policy: tool used by central banks to manage the economy by controlling the money supply and interest rates. Hawkish policy raises rates to control inflation.
Current Account Deficit: when a country imports more goods, services and capital than it exports, leading to a net outflow of domestic currency to foreign markets.

Author's Opinion

Measures such as increased government spending and cuts to income tax may initially seem beneficial to the population. However, the real impacts appear later, when inflation rises and purchasing power declines. Quality of life worsens and households face a more restricted and financially unstable reality.

Often, the official discourse tries to discredit criticism, stating that it’s just the elite who don’t want you to have access to more benefits, but the reality is quite different: those who suffer the most from inflation are the low and middle income populations. The elite have ways to shield themselves—through dollarized real estate, inflation-indexed financial assets or foreign income—and are therefore better able to absorb the impact. Meanwhile, the most vulnerable face rising prices on essentials like food, transportation and rent, and watch their salaries lose value month after month.

Researched by

Lucas Terhorst

Amsterdam, Notheastern University

Sources

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