Brazil—the fifth largest and most populous country in the world—occupies roughly 50 percent of the landmass in South America. Its coastline extends for 4,578 miles along the Atlantic Ocean, and rainforests make up almost 60 percent of the country. Given Brazil’s size, it’s no surprise that its economy is currently the seventh largest in the world by GDP.
However, much like its neighboring Latin American countries, Brazil experienced poor economic growth in the late-20th century. As a continuation of the Latin American fiscal policy project, Tim Kehoe, Juan Pablo Nicolini, and Thomas Sargent are collaborating with teams of economists and policymakers from 11 Latin American countries to analyze economic data from the region to understand how the fiscal and monetary reforms of the 1990s impacted each individual economy.
The case study for Brazil, organized by Marcio Garcia, was hosted at PUC-Rio this past fall. In attendance were several key stakeholders who were in office during Brazil’s period of hyperinflation, throughout the implementation of the Real Plan, and while institutional reforms were accomplished in the years that followed. During the daylong workshop, the group examined the fiscal and monetary history of Brazil and shared their insights on the challenges and successes they experienced while in their positions.
Brazil in the 20th Century
Following the Great Depression, Brazil went through several decades of political and economic unrest. The inequality gap was among the worst in the world; by the 1950s, over half of Brazil’s population suffered from malnutrition, and only one in three children had access to education. As demands for access to healthcare, education, and jobs rose among city-dwellers, tensions increased between the existing government and the business elite, and in 1964, the Brazilian military staged a coup, forming a dictatorship that lasted until 1984.
The military regime instituted a series of financial reforms in 1964-65, which introduced domestic debt and indexation, created a Central Bank, and adopted a banking system that separated commercial banks from non-banking institutions. Brazil saw a growth in manufacturer and consumer exports and the GDP experienced a 10 percent growth rate annually throughout the early 1970s, leading to an inflow of foreign capital.
The Brazilian government continued on a high growth path throughout the 1970s, but after the 1979 oil shock, foreign debt increased as wage adjustments began to occur more frequently. In 1983, there was a 30 percent devaluation of national currency, and Brazil saw hyperinflation skyrocket to annual rates of over 1000 percent throughout the next decade.
When Policies Fail
Between 1986 and 1991, several stabilization plans were implemented in an effort to reduce inflation—five of which were outlined in Garcia’s paper, co-authored by Diogo Guillén, Patrick Kehoe, and João Ayres. These plans—characterized by attempts to freeze prices and adjust wages, introduce new currency, create a fixed exchange rate, and propose new fiscal and monetary policy—failed to provide a long-term solution for inflation.
A major weakness of the five failed plans was that there was no credible fiscal reform, Garcia remarks. “Fiscal numbers don’t tell the whole story. Many changes in fiscal policy were made and did not produce an immediate effect. There are many more institutional details that help us tell a better story of Brazil.”
Former policymakers were able to shed light on some of these institutional details, including how the formation of the Central Bank and the relationship between government municipalities impacted the effectiveness of fiscal and monetary policy prior to the introduction of the Real Plan in 1994.
When the Central Bank is Not a Central Bank
“In 1993, it’s fair to say that the Central Bank was still dominated, not only by the Bank of Brazil but by the 5 federal banks and the 45 state banks. That’s a total of 50 banks that had direct access to the money printing mechanics,” said Gustavo Franco, former governor of the Central Bank. “The Central Bank wasn’t the monetary authority. The monetary authority was the National Monetary Council.” With public finances in complete disarray, there was little that the Central Bank could do to prevent hyperinflation.
The Power of Politics
Issues surrounding the execution of fiscal policy also contributed to hyperinflation.
These issues stemmed from changes in government administration and disagreements between municipalities. For instance, in 1989, Congress proposed the Summer Plan, a hybrid plan that attempted to privatize public-owned assets and wages. However, before the plan could be implemented, political power shifted and the privatizations were canceled.
Other stabilization plans also attempted to decrease the number of civil servants and close underutilized public firms but were then overruled by the courts. Furthermore, the workweek was reduced from 48 hours to 44 hours, and overtime wages increased. States could not afford to pay civil servants and continued to borrow from the Central Bank without interest.
Nicolini remarked that Brazil’s indexation policy was different from other Latin American countries, and was one of the primary contributors to the extended period of hyperinflation. “What started out as a simple procedure was generalized,” he said. While price freezing and wage adjustments slowed inflation rates, they could never be implemented long term. Prices continued to increase so frequently that despite wage adjustments, consumers were still unable to afford goods.
The Real Plan
In 1994, the Brazilian government implemented stabilization plan that would finally end over a decade of hyperinflation: the Real Plan.
By utilizing an interim non-monetary, the Unidade Real de Valor (URV), the Real Plan succeeded in introducing the Real, and dollarizing Brazilian currency. This opened the Brazilian economy up to foreign trade and accelerated the privatization program and closure of state banks.
A large attribution to the Real Plan’s success was that its fiscal component was negotiated and supported by Congress prior to its implementation. Edmar Bacha, a former professor at PUC-Rio and one of the designers of the Real Plan, remarked that getting Congress to pay interest with taxes rather than through issuing additional debt was a pivotal step in defeating hyperinflation.
Both Eduardo Loyo, the Central Bank deputy governor in 2003, and Amaury Bier, the second in command at the Ministry of Finance from 1999 to 2002, noted how the changes in government leadership challenged policymakers’ ability to meet targeted inflation goals during the financial crises of 1999, 2001 and 2002, emphasizing the deterioration of fiscal and monetary stances in recent years.
How Research Informs Policy: Looking Forward
The workshop concluded with a panel featuring Pedro Malan, the Central Bank governor prior to the Real Plan’s execution and finance minister in the period 1995-2002; Pérsio Arida, one of the main designers of the Real Plan and Central Bank governor at the start of the Real Plan’s implementation; and Tiago Berriel, an economic professor at PUC-Rio. The panelists examined the recent changes in government administration and debated whether or not there was evidence of fiscal dominance occurring in Brazil. They all agreed that it was difficult to design an empirical test that perfectly measured the likelihood of a fiscal meltdown.
Today, Brazil is home to over 200 million residents. Throughout the past several years, there has been a focus on updating the country’s technological infrastructure to prepare for international events such as the 2014 World Cup and the 2016 Summer Olympics, giving Brazil a competitive edge in the global economy; however, there has been a marked deterioration on the fiscal policy stance since the beginning of this decade.
“They made institutional changes which survived the first political transition between the party who implemented the changes to the party that was in opposition, but that arrangement started weakening over the past four years of government,” Nicolini remarked, referring to the inflation rates seen in recent years.
“Losing fiscal stance would be really, really bad, especially with the social impact,” said Garcia. “We have the conditions to change that. Brazil is a big and very powerful economy, and we can do much better.”
Nicolini, Kehoe, and Sargent hope that by studying the fiscal and monetary history of Latin America, economists and policymakers will be able to use the information learned to avoid repeating mistakes from the past. Still, while each country shares many commonalities, understanding the differences in economic policies of individual countries is imperative.
“Both countries had very high inflation in the 80s, and both countries stopped inflation in the 90s. But they did it in a different way,” said Nicolini, reflecting on the differences between Brazil and Argentina. “2001 and 2002 were very difficult years for all Latin American countries. The Argentinian Plan collapsed and changed their policy, while Brazil survived and didn’t change their policy.”
“We have to give more attention to the foreign sector in Brazil and constraints that come from the foreign sector by trade and capital flows. That’s closely linked to the fiscal problems, and we didn’t pay enough attention to that aspect in the current version of the paper,” said Garcia. “Many of the presenters here gave us big leads on where to get new data and also where to get more references that will help our research.”
Country-specific case studies will continue throughout 2016, with the most recent workshop taking place at the University of Chicago in January, adding to the body of research already gathered from workshops in Argentina, Chile, Bolivia and Brazil.