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Brazil fights a Real battle

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mark donohue

on 28 March 2011

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Transcript of Brazil fights a Real battle

Why have Brazil’s interest rates generally fallen in recent years?
Brazil Fights a Real Battle Tradeoffs of accelerating the Real’s depreciation? Financial Problems Plaguing brazil Prior to 1998 financial crisis
Significant current account deficits

Wild public spending

Large amounts of foreign debt Result? Pressure to devaluate the Real Crawling Peg Asian Financial Crisis Investors lost confidence in developing nations
Large capital outflow from Brazil
Difficulty maintaining the crawling peg
Trade-off Attempt to maintain crawling peg
Let market forces dictate currency value
Central bank = spend reserves

May lead to complete financial collapse if reserves are depleted

Investors may become sceptical over feasibility of the policy Inability to repay foreign debt

Disastrous to importers

Significant loss of foreign investment

Revert back to high infliation.
Could Brazil have avoided the recessionary impacts of its monetary policy if it had devalued the Real instead? Prior economic troubles Indirect financial crisis + = Brazil would have been negatively affected either way Benefits of Voluntary devaluation Demonstrates transparency
-- Can regain investor confidence

Can't avoid problems, but can lessen the effects Question 3 Recent years: 1994 to 1997
Interest rates= real interest rates
1993 Real Plan: Crawling Peg, 0.6% depreciation
Key data:
Exchange rates: 0.119 Real/$ in 1993 to 1.1166 Real/$ in 1997
Inflation rates: 2828.7% in 1993 to 7.2% in 1997

Fisher Effect: drop in inflation rate drop in real interest rates
Question 4 Question 5 What are the costs and benefits of using currency controls to defend the real?
End to Brazil’s runaway inflation
Declining interest rates
Currency stabilization
Increased investor’s confidence in the economy
Current account deficit
Exacerbating effects of extraneous events: 1997 Asian Financial Crisis
Question 6 1. A negative sign indicates a budget surplus.
2. Other components of foreign investment are relatively minor.
3. Exchange rate for the real prior to 1994 reflects the effects of two earlier currency replacements. Question 2 President Cardoso’s Reform Social Security ReformBrazil’s Savings Rate16%Asian average Savings Rate30% What would happen if Brazil Privatized
its Social Security System? Consequences Saving's Rate Real's Value Current Account Employee pays portion Employer pays the other portion Social Security Trust Fund President Cardoso's Reform Brazil's Savings Rate 16% Asian average Savings Rate 30% Social Security Problem Consequences Larger and larger deficit Bankruptcy Problem Solving Raising Payroll Taxes Cutting Pension Benefits Increasing Returns on Collected Revenue Overall Result = Savings Rate Higher than 16% Public Domestic
Investment Current Account Foreign Investment Brazilian Economy would increase FDI (+) = Capital Account (+) Ultimately =Current Account (-) Real's Value With more Money Invested Firms increase: Value Productivity Increased Productivity = Lower inflation Rate
Increasing Real Value
Compared to higher inflation countries Bad Outcome Workers making bad investment decisions Workers taking that saved money to: -Buy new sports cars
-Pay bills Untouchable until retirement Question 9 Question 10 devaluation catastrophic for neighbouring countries because 1) will make trade more expensive for Brazil, thus diminishing it - Large budget deficits due to President Cardoso's policies of Pegging Real to US dollar has brought inflation down from 50% per month to 7% annually, however: 3) the rich get richer, the poor get poorer; the Brazilian government is spending more to support the growing number of unemployed citizens 1) interest rate has risen to 43% 2) unemployment rate is rising at a rapid pace 2) Brazil represents 45% of GDP in Latin America
3) Contagion should spread to neighbouring countries due to speculation Introduction and Background Information -1994 Fernando Cardoso was elected president.
-Cardoso stabilized the currency and brought inflation down to just 7% annually by 1997.
-He introduced the “REAL PLAN” in 1993 while he was finance minister -Brazil has a bloated public sector.
-large budget deficits (5.9% of GDP in 1997)
-protected industries
-high tax rates with low tax collections Elections on October 1998.
-Tight-money policy imposed by Cardoso

Government main weapon to stanch Brazil's fiscal and trade deficits
is a newly invigorated privatization program.
-Brazil's population: 160 million of people
-GDP: $800 billion (has grown at an average rate of
more than 4% annually since 1993.

-Largest market in Latin America (45% total GDP of Latin America)
-Industrial products now account for 75% of Brazil's exports.
2) How will Brazil’s tight money policy affect its fiscal deficit? How will it affect Brazil’s real (inflation-adjusted) interest rates, both short term and long-term rates? -inadequate fiscal consolidation led to fears of default, high interest rates, and a consequent debt spiral Overall, the plan was successful in targeting inflation, even though the fiscal reform was not as efficacious as expected and despite the fact that Brazil was still facing an uncomfortable debt. The current government is still dealing with the effects of these past policy decisions, battling the expectations for high inflation among its citizens Question 1
1.How does Brazil hope to control its current account deficit through a tight monetary policy? What alternatives are available to control Brazil’s current-account deficit? The key issue Brazil had was underemployment, and excessive account deficits. Fernando Cardoso hoped to control the current account deficits with tight monetary policies by supporting the currency (real), and preventing the trade deficits. Cardoso coordinated with the Brazilian Central Bank to defend the Real Plan by doubling by doubling the interest rate by 43% as well by emphasizing budgetary reforms with spending cuts and tax increases up to $18 billion. Another alternative method of controlling the current account deficits is through devaluation of the currency (Real), which has implied in Brazil in 1999 Question 11 What mix of fiscal and monetary policy
would you recommend to President
Cardoso? Should he devalue or defend the
real? During periods of economic slack, a loose fiscal-easy money policy can be apply. It is highly stimulative.
-consist on budget stimulus and rapid growth in bank reserves. -Cardoso should devalue the Real The option is to give devaluation a chance,to let the markets push the currency (real) down, without raising interest rates. Why not defend the Real?
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