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Accelerating inflation
Slowdown in GDP growth
Severe foreign exchange shortage
Affected production especially in
industrial sectors
Stabilization and Reform,
1964-67
On March 31, 1964, military coup occurred and
Army Marshal Humberto Castelo Branco
became the first President of the Military regime
Economist Roberto Campos was appointed
planning minister.
Immediate economic concerns:
Rising inflation
Worsening external payments position
Stabilization program included,
Strict control of public debt
Restrictions on credit and wages
Stabilization and Reform,
1964-67
Fiscal strategy consisted of:
increase in direct and indirect taxes
Reduction of subsidies through realistic pricing of
public utility services
Increased tax revenues through the indexing of
tax rates
Financing of government debt through the sale of
bonds.
The authorities established monetary growth rates of
70 percent for 1964. 30 for 1965, and 15 for 1966.
Stabilization and Reform,
1964-67
Credit expansion during the 1964-66 period was 18.5
percent below the mean for the 1960-62 period.
But an increase in net foreign borrowing and foreign direct
investment, and the fixed nominal exchange rate resulted
in an unintended monetary expansion.
Under a law passed in 1965, nominal wage adjustments
could only be made at twelve-month intervals and had to
take into account the official inflation forecast, the
average real wage of the preceding twenty-four months,
and an officially mandated "productivity gain.“
Stabilization and Reform, 1964-67
Short Term Effects
Inflation fell from an annual rate of 90 percent in 1964 to
about 25 percent in 1967.
The federal deficit fell from 4.2 percent of GDP in 1963 to
1.1 percent of GDP in 1966
Monetary financing of the deficit fell from about 85
percent in 1963 to about 13 percent in 1966
Foreign payments arrears of $300 million in 1963 were
replaced by reserves of about $400 million by 1966.
The real GDP growth rate increased from 1.6 percent in
1963 to 5.1 percent in 1966 and 4.8 percent in 1967.
Stabilization and Reform, 1964-67
Long Term Effects
The economy's allocation mechanisms were
deeply compromised
In principle, the government's strategy was an
economic democratization carried out under
government supervision.
The government would use its policy instruments
to allocate resources according to its own
predetermined objectives and the demands of
those interest groups that were still allowed a
voice by the government.
In reality, government supervision did not end.
Instead, it multiplied.
Stabilization and Reform, 1964-67
Long Term Effects
The government increasingly disregarded
price mechanisms to allocate resources.
The efficacy of price mechanisms was
further compromised by Indexation.
Indexation sped the transmission of
shocks to other sectors of the economy
and increased the variance of the rate of
inflation.
Brazil: 1964 -1967
Negative side:
The government’s lack of concern about
allocative efficiency suggests that intervention
exacted a high price in welfare terms.
No institutional checks and balances
Increased degree of uncertainty surrounding
economic decisions.
Inflation and Indexation
The root of Brazilian inflation :
Monetization of part of the government's
deficit.
Inflation took its first substantial leap in
the period after World War 11.
Reaction to Inflation:
Tightened fiscal policy, increased
prices for
public services to levels that would
cover costs, and reduced the growth
of government services. in order to
reduce the deficit that underlay
money supply increases
Extensive system of indexation, or
"monetary correction."
(i) high nominal and real interest rates in order to achieve price stability;
(ii) growing liberalization of the capital account in order to integrate
Brazil to international capital markets;
(iii) overvaluation of domestic currency.
(iv) since 1999 an increasing primary fiscal surplus – generated mainly by
the reduction of public investment – in order to stabilize public
debt/GDP ratio.
Alternative economic policy model
Adoption of a crawling-peg exchange rate regime in which
devaluation rate of domestic currency was set by the
Central Bank at a rate equal to the difference between a
target inflation rate and average inflation rate of Brazil’s
most important trade partners
Adoption of market-based capital controls in order to
increase the autonomy of the Central Bank to set nominal
interest rates according to domestic objectives (mainly to
promote a robust growth)
Reduction of nominal interest rate to a level compatible
with real interest rate
Reduction of primary surplus from current 4.5% of GDP to
3.0% of GDP. These elements are fundamental for the
required increase in the investment rate of Brazilian
economy from current 20% of GDP to 27% of GDP needed
for a sustained growth of 5% per year.
1)The first principle of the “alternative economic policy model”
entails the abandonment of the current Inflation Targeting Regime
(hereafter ITR).
.... For the workings of this system, however, there must be a
floating exchange rate regime.
……Adoption of a crawling-peg exchange rate regime will reduce
the exchange rate risk.
•crawling-peg exchange rate regime is that it will serve as nominal
anchor for the Brazilian economy, substituting ITR as a device for
inflation control.
2). The adoption of capital controls. These controls are necessary for
two basic reasons.
a) Increase private investment b) Control over nominal exchange
rate.
• To reduce capital inflows, it is necessary the introduction of reserve
requirements over all capital inflows, except foreign direct
investment
Current challenges
Brazil remains far from the full employment :8.2 percent
Controlling inflation:6.4%(Present)-4.5 %(Target)-Food Prices
Agricultural prices have risen substantially in the last few
months, a trend that may begin to be seen in other sectors,
given the huge increase in internal demand
lack of technically qualified people to attend to certain sectors
Insufficient electricity generation to support a lengthy period of
economic growth.
The large trade surplus from agricultural and mineral
commodities, and the influx of speculative capital stimulated by
high interest rates, without neutralizing measures, causes
overvaluation of the real, which in turn undermines the
competitiveness of national industry, resulting in lower exports
and an invasion of cheaper imported goods.
Lesson’s from Brazil