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INFLATION AND EXTERNAL DEBT IN BRAZIL.
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Discusses problem of Brazil's persisting high inflation over a long period of time, and large foreign debt.... More...
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Paper Abstract:
Discusses problem of Brazil's persisting high inflation over a long period of time, and large foreign debt. Examaines the current situation of Brazil's unbalanced economy. Brazil's attempts to reduce inflation. Identifies origins of Brazil's economic problem. Government plans and failure to stabilize the economy. Brazilian theory of "intertial" inflation.

Paper Introduction:
TRAPPED IN INEQUALITY? Persisting Inflation and External Debt in Brazil Introduction No other nation has experience so much inflation, persistantly, over a long period as Brazil has. Hyperinflation in other countries has produced astronomical price increases, but hyperinflation is a shortlived process, whereas Brazil's inflation has operated for decades. Brazil also has a long history of high foreign debt, going back to the 1920s, and in the early 1990s Brazil had the world's largest external debt, at a level of about $118 billion.

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In many ways, then, Brazil has more in common with the newlyindustrialized countries than with "periphery" economies trapped independence on commodity exports and industrial imports. In fact, from the account given above, the "Plans" seem to havelacked credibility from the outset. Some observers, however, have expressed concern that Fraga'sstabilization policy is based too heavily on investor psychology (Katz andCohn, 1999). The Theory ofInertial Inflation. However, the measures undertaken by Brazilian Central Bank governorArminio Frago to control influation have included very high interest rates,at one point in 1999 raising the rate from an already very high 39 percentup to 45 percent (Katz and Cohn, 1999). The Letter of Intent went on to note that consumer prices (IPCA) hadrisen by 6. The Letter of Intent was also cautiously optimistic about Brazil'sforeign debt. http://www.imf.org/external/np/loi/2 1/bra/ 1/index.htm Katz, Ian; and Cohn, Laura (1999). However,imports grew more quickly, by 13 percent overall and 24.5 percent forintermediate or capital goods. Hyperinflation in other countries hasproduced astronomical price increases, but hyperinflation is a shortlivedprocess, whereas Brazil's inflation has operated for decades. Thiscan be seen most clearly during the period of military rule between 1964and 1985. inflation declined again in the remainder of the year(International Monetary Fund, 2 1). The authors have developed this theory in a book, which was notavailable; the excerpt above is taken from one of the authors' websites.Unfortunately, this brief excerpt does not fully develop the theory. In 1979, inflationwas still running at 5 percent a year. It then started to increase, in aseries of jumps, until by 1984 it had reached a level of 35 to 4 percentannually(Bresser-Periero and Nakano, 1992). However, the military junta was not more successful than previouscivilian governments in curbing inflation. Inflation also dries up sources of domesticcapital, due to the loss in value of loan payments, so domestic capitalcannot be efficiently mobilized. administeredprices (including electricity, telecommunication, and transporttariffs, and prices of oil products) and of adverse weatherconditions ... Afull explanation of Brazil's inflation would probably also require anexplanation of its history of debt, since the two seem closely related --as in the early 199 s, when Brazil was the world's largest debtor, and alsoexperienced inflation peaking at 2 percent. The latest Plan was no more successful than any of theprevious ones: "The Second Collor Plan, now over a year old, has had aboutthe same effect as all the others" (Asset International, 1992). Contemporary capitalism has an inertial component. International Monetary Fund (2 1) Letter of Intent (from governmentof Brazil). Inertial Inflation, Indexation and PriceStickiness: Evidence from Brazil. Business Week (May 1 ).----------------------- 1 Brazil: The Macro Picture. Durevall (1999) argueson statistical grounds that the periods of highest inflation in Brazil donot correspond to periods when indexation and other measures that reinforce"inertia" were in effect. Brazil has possibly the mostunequal income distribution in the world: Brazil's Gini coefficient (a measure of income inequality thatranges from for perfect equality to 1 for absolute inequality) wasaround .6 , as compared to an average of .42 for its Latin Americancounterparts (Feinberg, no date). The level of inflation will be maintained even in the absenceof such traditional explanatory factors as public deficits and excessdemand (Bresser-Periero and Nakano, 1992). References Arnold, Heather (no date) Will the 21 st Century Belong to Brazil?Templeton Management (report).http://www.fttrust.com/library/investment_insight3 .pdf(Note: This document is missing, but is cached by Google at:http://www.google.com/search?q=cache:l6w61BjQ1n8:www.fttrust.com/library/investment_insight3 .pdf+brazil+inflation+debt+inurl:pdf&hl=en) Asset International (1992). The availablematerial does not discuss the various "Plans" of the 198 s, all of whichfailed to stop inflation, but presumably regard them as half-heartedmeasures. They also attempted tojolt inflation to a halt by imposing a price freeze, and made attempts aswell to eliminate "indexation" -- the automatic increase of governmentpayments, which tended to produce continuing inflationary pressure -- andtried as well to curtail government spending and hold down increases ininterest rates (Asset International, 1992). Income inequality in Brazilis therefore extreme. 16-18. The following discussion traces the modern development of Brazil'scombined inflation and debt problems, and seeks to identify their origin.The discussion begins by outlining the current situation, followed by achronological account, with particular focus on inflation. Inflation was reduced, but the strain onBrazil's financial system was so great that some of the frozen accounts hadto be "unfrozen" within two months (Asset International, 1992). This has required heavy governmentborrowing, to the point where the government's domestic debt in 2 equaled 4 percent of GNP (Arnold, no date). A solution to Brazil's inflation and debt patternwill thus require a social as well as economic response. In1992, the International Monetary Fund also granted a $2.1 billion "standby"loan to Brazil. 37 (March), pp. In the longer term, however,inequality is a drag on the growth of the Brazilian economy, since themajority of the population cannot afford the products of Brazilianindustry. All three plans failed: Confidence dwindled after each successive plan to the point whereconsumers spent most of their time speculating against the government'snext round of price freezes ... Asearly as 1955, inflation in Brazil was at an annual rate of 15 percent.This increased through the late 195 s and early 196 s until it reached 8 percent in 1964 (Bevilaqua and Garcia, no date). As a result, they havecome up with a distinct theory of inflation, growing out of the Brazilianexperience: the theory of "inertial" inflation. (No date). Brazil would remain under military rule until 1985(Asset International, 1992). Theseprojects created the illusion of economic progress, tamping down politicalpressures at the price of inflation. Similar processes, though less blatant, have probably operated beforeand after the era of the junta. Most of this is in the formof short-term debt (Fraga, 2 ). DebtManagement in Brazil: Evaluation of the Real Plan and Challenges Ahead.http://ideas.uqam.ca/ideas/data/Papers/wopwobadc24 2.html Bresser-Pereira, Luiz; and Nakano, Yoshiaki (1998). Inflation and debt, we may suggest, are twinoutgrowths of this severe inbalance in the Brazilian economy. As stated at the beginning of this essay, Brazil has had morepersisting inflation over a longer period than any other country in theworld. However, the creators of the inertial theory also were influenced bythe Latin American structuralist theory (Bresser-Periero and Nakano, 1992),which argues that underdevelopment in the "periphery" persists due to itsfundamental economic inequality with the fully industrialized economies, or"core." (This point will be further discussed below.) Large conglomeratesin "periphery" economies have great autonomy, and can continue to raiseprices even when the economy is in recession. (Book summary on co-author's website.)http://www.bresserpereira.ecn.br/books/22livro.htm Durevall, Dick (1999). Few in Brazil really believed thatserious measures were intended, or would be carried out, so "inertia"remained intact, and inflation quickly resumed. Because of this experience, Brazilian economists have naturally hada particular interest in and concern for inflation. percent during 2 , as compared to 8.9 percent in 1999, whilethe general price index (IGP-DI) had increased by 9.8 percent in 2 , downfrom a 2 percent increase in 1999. Inparticular, it does not explain in detail how inertial inflation differsfrom "rational expectations" inflation, which also results from people inthe economy taking a certain level of inflation for granted, building itinto their own actions, and thus perpetuating it. While a positive attitude by investors is desireable -- infact, it is necessary in order to gain access to capital -- investorpsychology can turn around very suddenly. We saw earlier that the military government used (inflationary)internal borrowing to fund development projects in the 197 s. We have already seen that theoptimism of investors in 1991, which led to a sharp increase in theBrazilian stock market that year, failed to result in sustained growth or astabilized economy.Inertial Inflation? However, in onefundamental way Brazil is very much a Third World economy: the continuingexistence of very large-scale poverty. Persisting Inflation and External Debt in BrazilIntroduction No other nation has experience so much inflation, persistantly, overa long period as Brazil has. Theinertial school does not attribute inertial inflation simply to indexation,as Durevall seems to presume. Moreover, inertial theory does not necessarystate that inflation will be highest during periods of indexation, onlythat inflation will persist, and drift back toward higher levels. Freezing bank accounts caused a crisis in liquidity-- since savers could not get to their money -- and resulted in s steepdecline in economic output. All three ofthese Plans involved devaluation of the currency. Inflation, which had reached 2 percent in 1994,briefly dropped as low as 2 percent in 1998 (Arnold, no date). Inflation in Brazil.http://wueconb.wustl.edu/~e1 4le/fa97/urls/FEINBERG--ALISON-HELENE/page/ Fraga, Arminio (2 ) Monetary Policy During the Transition to aFloating Exchange Rate: Brazil's Recent Experience.Finance and Development, v. Apart from its sheer size -- with a population well over 15 million,Brazil was the tenth largest economy in the world by 1992 -- a majority ofits exports are manufactured products, unlike its neighbors Argentina andChile. The stress and tensionscreated by this growing inflation were one of the factors that led in 1962to a military coup. "External accounts continued to improve in 2 , albeit at apace slower than initially projected," from $6.6 billion (US) in 1998 and$1.3 billion in 1999 to $ .7 billion in 2 . The term "tradable goods" was not otherwise defined, butpresumably meant some class of capital goods, since the index that includedthese goods rose at a higher rate both years than the consumer price index. The advocates of inertial-inflation theory argue that, when facedwith persistant high levels of inflation, even in the absence ofconventional sources of inflation -- that is, in conditions in whichinertial inflation has taken hold -- "policymakers must adopt a policy ofheterodox shock: the instantaneous freezing of all prices, wages, andexchange rates" (Bressere-Periero and Nakano, 1992). Journal of Development Economics, 1999,pp. After only four years, the new Braziliancurrency, the cruziero, had to be replaced by another one, the real(Bevilaqua and Garcia, no date). This Plancalled for freezing 8 percent of the nation's private savings in banks forup to two years, by abolishing the Brazilian currency, the cruziero, andreplacing it with a new currency, the cruzado (Asset International, 1992).Yet another new currency, the real, would replace the cruzado in turn, in1994 (Bevilaqua and Garcia, no date). Between 1997 and 1999, according toFraga (2 ), Brazil moved from a "primary" debt equal to 1 percent of GDPto a running surplus of 3 percent of GDP. Moreover, extreme inquality produces political pressures. By the end, inflation had grown worse andthe budget deficit larger (Asset International, 1992). Sarney. However, the critique itself is flawed. Since thattime it has increased somewhat, but remained below 1 percent(International Monetary Fund, 2 1). Instead, the junta used publicdebt to fund various development projects, producing continuinginflationary pressure (Bevilaqua and Garcia, no date). International developments placed further pressure on Brazil in thesecond half of the 199 s, when its efforts to manage its foreign debt werecomplicated by first the Asian crisis of 1987-88, and then the financialcrisis in Russia (Arnold, no date). Nevertheless, the Brazilian stock market was booming -- in 1991, theBolsa de Valores Sao Paulo went up some 151 percent in US dollar terms. The combination ofinflation and debt suggests that something is structurally unbalanced inthe Brazilian economy.An Unbalanced Economy Brazil does not fit the conventional image of a Third World economy,exporting mostly commodities such as raw materials and agriculturalproducts, and needing to import most of its manufactured goods from abroad. Wage increases and indexation ofgovernment payments give the appearance of rising incomes, but it is onlyan illusion due to inflation. The Sarney government launched a series of "Plans" that were intendedto control inflation and debt, and revitalize the economy. TRAPPED IN INEQUALITY? Thus, conventional anti-inflation measures, which subject the economy to a temporary recession inorder to undermine inflationary pressures, are ineffective. International lenders had takenenormous losses when Asian and Russian loans went bad, and were morereluctant to lend to emerging economies, including Brazil. In January of 2 1, the consumer price index had risen only by .57percent, the lowest January inflation rate since the IPCA index was startedmore than 2 years ago (International Monetary Fund, 2 1). This "National Stabilization Plan," we are told, "hit the countrylike a barrel full of buckshot with much the same effect" (AssetInternational, 1992). Latin America as a region is noted for its high level of incomeinequality, yet Brazil scores nearly 5 percent higher on the Gini scalethan the other large Latin American economies. Considerationis given to a theory of "inertial" inflation, developed by Brazilianeconomists, and the essay concludes with a proposal that inflation and debtare both rooted in Brazil's highly unbalanced economy.The Current Situation Brazil recently submitted a "Letter of Intent" to the InternationalMonetary Fund (IMF), in order to demonstrate its improved creditworthiness. Feinberg, Alison (no date). (Infact, upward trends in Brazilian inflation have not been gradual butabrupt, in a series of upward jumps; Bressere-Periero and Nakano, 1992.) By itself, inertial theory can neither be taken as the finalexplanation of Brazil's persistant inflation, nor rejected out of hand. By 1994, inflation was entirely out of control, reaching 2 percent (Arnold, no date). Thus, the Letter of Intent admitted, The terms of trade improved by only 3 percent from thedepressed level of 1999. Unfortunately for millions of Brazilians, the stock market increaseand International Monetary Fund loan did not prove to be a turning point --a fact that leads to some doubt about similar optimistic remarks made morerecently. The first ofthese was the Cruzado Plan in 1986, followed by the Bresser Plan in 1987,and the Summer Plan in 1989 (Asset International, 1992). Pulling Brazil Back from theBrink. No purely mechanical solution thatignores the underlying cause, extreme inequality of income, will succeed inbreaking this cycle. However, by the late 199 s, Brazil's financial situation showed majorsigns of progress. Inertial theory is not without its critics. GlobalCustodian (March).http://www.assetpub.com/archive/gc/92- 1gcmarch/Mar92GC 35.html Bevilaqua, Afonzo S.; and Garcia, Marcio G.P. Brazil alsohas a long history of high foreign debt, going back to the 192 s, and inthe early 199 s Brazil had the world's largest external debt, at a level ofabout $118 billion. By 1992,Brazil was the world's top debtor nation, with an external debt that hadreached a level of about $118 billion. (Only in 199 did Brazil have apresidential election, for the first time since 196 , electing FernandoCollor de Mello; Asset International, 1992). By 1992, Brazil also had the largest foreign direct investment ofany country in the Third World, totalling $32 billion (Asset International,1992). This Letter of Intent summarized the progress that Brazil has made in thelast couple of years in reducing its rate of inflation: Continued progress has been made in reducing inflation.Following a temporary acceleration in the middle of 2 ... By 1991, the National Stabilization Plan was dead, replaced by stillanother one. Exports had risen sharply,by 11 percent overall and 17 percent for manufactured goods. In 199 , newly elected President Fernando Collor de Mello launchedyet another Plan intended to break the spiral of inflation. The junta's inability to control inflation discredited it, just asinflation had discredited civilian governments twenty years earlier.Military rule ended in 1985, and the junta was replaced by a civilian"caretaker" government under Jos? During JanuaryBFebruary 2 1, the tradebalance recorded a US$399 million deficit, reflecting a continued risein intermediate and capital good imports, and continued pressuresfrom oil prices (International Monetary Fund, 2 1).Persisting Inflation and Debt Brazil's struggles with inflation and foreign debt are not new. 4 7-421. Given thedistributive conflict, which leads economic agents automatically topass cost increases through to prices, the level of inflation experiencedin the past continues to be anticipated, and is therefore carried into thepresent. In the short term, the Brazilian economic elite benefits frominequality, since the cost of labor is low. Large firms and politically powerfulunions protect themselves by raising prices or their members' wages,perpetuating the inflationary cycle. "It is a turning point for Brazil," the head of theCentral Bank, Marcilio Moreira, was quoted as saying (Asset International,1992). The idea is todeliver such a strong jolt that "inertia" is broken. The difference was attributed to a"continued increase in the price of tradable goods" (International MonetaryFund, 2 1).

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