Sunday, May 30, 2021

Brazilian Inflation

This marvelous plot comes from an interesting article, The Monetary and Fiscal History of Brazil, 1960-2016 by Joao Ayres, Marcio Garcia, Diogo A. Guillén, and Patrick J. Kehoe. The article is part of the Becker-Friedman Institute Project, complete with a big and now easily available data collection effort, and forthcoming book

If you want a deep historical and economic analysis of fiscal and monetary interactions, this is an amazing resource. And it summarizes historical episodes that North Americans just might want to know more about soon! 

(HT Ricardo Reis who pointed it out in a great discussion last week, that I will post as soon as it's available.) 

To me the graph is at first blush a reminder that inflation can stop on a dime, despite sticky prices, seemingly adaptive or sticky expectations, Phillips curves, and so forth. Brazil seems to have had 6 Tom Sargent "end of inflations" episodes in 10 years! (Reminder: Tom showed that inflation can end very quickly if the underlying fiscal regime causing inflation changes.) 

It is also a reminder that politician promises are not enough, and inflation can come back pretty quickly as well. The steady upward march in 3/6 cases rather than immediate resumption of high inflation is interesting as well. But in Bresser, Summer, and Collor II, we also see an essentially instantaneous reversal. 

I have long thought that the US conquest of inflation had a fiscal and monetary part. The high ex-post interest rates of the early 1980s may well have represented a fear that we would return to inflation. And the fiscal and regulatory reform of 1982 and 1986 may well have had a more important role in cementing the stabilization than is commonly thought. 

The article is too rich to summarize, but here is some commentary on the above graph. (In the end there is so much price control going on that my first impression may be a bit too hasty. How much of the slowdowns in inflation just represents temporary price controls is a bit open.) 


The first plans were based on the idea that inflation inertia due to the highly indexed economy was the essence of the inflationary process, and breaking that inertia should be the main focus of the stabilization plan. These plans had a neutral shock [?] of freezing prices as one of their main characteristics. 

We know from the Nixon attempt just how well that works out, unless backed by actual policy changes. Inflation indexing was an important feature of the Brazilian economy.  

An alternative and more standard orthodox theory considers the persistent and large fiscal deficits as the main cause of the inflationary process, since the government had to increase the growth rate of the monetary base to raise seigniorage revenues to finance those deficits. 

from the first to the last plan, there was less emphasis on the heterodox part of the plan, which comprised price freezes, and more emphasis on the orthodox part. Fiscal and monetary policies became a major component of the latter plans while maintaining a device to synchronize the adjustment of nominal variables to avoid threatening the new low inflation level. 

 Cruzado Plan:

As what became standard in most Brazilian stabilization plans, the first rule was to change the currency, in that case from cruzeiro to cruzado, which meant cutting three zeros. Prices were frozen, and any indexation clauses for periods shorter than one year were forbidden.  Wages were converted into cruzados based on the average purchasing power of the last six months but could be readjusted every time inflation hit 20 percent or during the annual readjustment cycle. .... The exchange rate regime also changed, with the domestic currency now pegged to the US dollar. Fiscal and monetary policies were put under the discretion of the policymakers, but there was an important change... the creation of the National Treasury Secretariat, which would take control over both the administration of the domestic public debt and the government budget

"Under the discretion of policy makers" doesn't sound like a great regime shift, but the previous part of the paper documents just how much of Brazil's budget was not under control. In particular Brazil had a development bank with the right to print money to finance "infrastructure projects," and large state-owned enterprises. A later section "Weak institutions that provided indirect access to the printing press" covers this some detail. 

It all fell apart

One huge imbalance was the inconsistency of the plan for inflation and the monetary base: the monetary base was increasing much faster than inflation itself....In July 1986, the government implemented a timid fiscal package, Cruzadinho, focusing on increasing government revenues. But in reality, Cruzadinho had the opposite result of what policymakers expected....Imports kept increasing while exports declined...A rumor of a large devaluation in the near future reinforced that pattern. This expectation lead to a postponement of exports and an acceleration of imports, which increased the problems with the balance of payments.

An exchange rate peg is a fiscal commitment. 

Bresser Plan: 

In July 1987, the government implemented the Bresser Plan, named after Finance Minister Luiz Carlos Bresser-Pereira. It was presented as a hybrid plan, with fiscal and monetary policies as well as aspects to deal with inflation inertia. 

Bresser Plan: In July 1987, the government implemented the Bresser Plan, named after Finance Minister Luiz Carlos Bresser-Pereira. It was presented as a hybrid plan, with fiscal and monetary policies as well as aspects to deal with inflation inertia. As in the Cruzado Plan, prices were frozen. As usual, the moment in which the price freeze took place was important because the relative prices would remain stuck and possibly off-equilibrium. Trying to get a better result than the Cruzado Plan in this aspect, after the price freeze there was an increase in the prices of public services and some administered prices to correct for misalignments in relative prices...But the economic team created another kind of wage indexation,..

Micromanagement of relative prices, indexing, wage adjustments, and the equity aspects of price controls seem to be a big part of these plans.  

In the fiscal policy arena, the government aimed to reduce the operational deficit from the expected 6.7 to 3.5 percent of GDP. The plan did not address (or seek to deal with) the consequences of the previous default with creditors..

However, the reform was not successful. In 1987, the deficit was much higher than promised. Unlike the Cruzado Plan, which had popular support, the Bresser Plan was not popular,  ...

Rereading Tom Sargent's "Methods of Poincaré and Thatcher," popular support is an important force to keep the commitments of a new regime going. 

The latter two observations seem intertwined, and will make any US stabilization a messy affair. A stabilization needs popular support, and our government is obsessed with micromanaging equity, and does not hold back from micromanaging prices and wages in any emergency. Even the last US price controls fell apart with group after group pleading for special exemptions. 

Summer Plan: 

The government implemented the Summer Plan in January 1989. Again, it was a hybrid plan, but the debate on the need for changes in fiscal and monetary policies was increasing. Like the previous plans, it included a component of price freezing as well as the adoption of a nominal anchor. In this case, a fixed exchange rate (1 cruzado novo = 1,000 cruzados = US$1) was implemented for an indefinite time. 

Moreover, an attempt was made to end inflation indexation. 

On the fiscal and monetary side, the plan was to adopt a tight monetary policy and to fight inflation by controlling the public deficit. It intended to control expenditures and increase revenues through the privatization of publicly owned assets and a reduction in the wage bill of the public sector.

Should it come to that, government employee and teachers unions and pensions will be part of the US stabilization plan. I say that just to say how hard seemingly anodyne policy plans are. 

Overall, the plan seemed to incorporate everything that was missing in the previous plans. Although it kept a heterodox flavor, it was mostly an orthodox plan aiming to reduce subsidies, close public firms, and fire public employees, with a deindexation plan that was sort of a small default. However, the government did not have the political power to carry it through. Without Congress, privatizations and other unpopular measures, such as the closing of public firms, were canceled. In the end, the reforms were not implemented. Moreover, the tight monetary policy put interest rates at high levels and increased the fiscal deficit of the government. With low credibility and a reform that did not go through, inflation accelerated, and the Summer Plan also failed. 

My emphasis.  To change a regime, one needs durable policy. And higher interest rates can lead to a doom loop. On the other hand a true Sargent end of inflation usually involves instantly lower interest rates and printing more money. So the lack of credibility of the plan may show right there. 

Collor Plan.

The very day he took office, he launched the first Collor Plan...

Prices and wages were frozen. The plan recognized that a reduction in deficits was necessary to end the hyperinflation, and it implemented both temporary and permanent fiscal policies. ... An effort was made to reduce fiscal evasion (one of the president’s trademarks during the presidential campaign) and increase taxes. Other major components included privatizations and an administrative reform. 

However, that plan became famous for its (controversial) monetary policy. In an attempt to reduce the money supply, the government confiscated deposits in both transaction and savings accounts for a period of eighteen months. Those resources amounted to 80 percent of bank deposits and financial investments, which would be held at the Central Bank of Brazil and invested in federal government bonds. These resources were remunerated while they were kept at the central bank, but their rates of return were decided by the government itself and therefore were subject to partial defaults.

Defaulting on debt avoids inflating it away. But when the problem is future deficits not past debt, that is not going to help

The plan encountered a lot of resistance, and in the end, it could not deliver on what it had promised. While some privatizations succeeded, most of its reforms were short-lived. 

Collor Plan II:

In January 1991, the same government implemented the Collor Plan II. Just like the previous one, it planned to reduce government expenditures by firing civil servants and closing public services. It also proposed the privatization of state-owned enterprises. As usual, the plan included some price freezes.  

To make this come alive, just imagine firing civil servants in the US to save money. 

the government opened the Brazilian economy to foreign competition and privatized state-owned firms.

Microeconomic reform is often a part of successful stabilizations. 

Following the plan’s implementation, the country experienced a recession. But it re- covered afterward, and this recovery is usually attributed to enhanced competition in the economy. 

Yet not all was well 

Following the high political turbulence that characterized the months preceding the impeachment of President Collor de Mello (October 2, 1992), the beginning of Itamar Franco’s presidency was marked by high uncertainty concerning economic policy. Proposals of another moratorium, and even repudiation of the public debt, were constantly in the press.  

Real Plan: 

In February 1994, the government launched its last stabilization plan, the Real Plan, which would finally put an end to the hyperinflation. The plan that conquered Brazilian inflation did not have the blessing of the IMF, an always troubled relationship in the previous decades. The plan’s concepts were different from the previous ones: it aimed to reduce deficits, modernize firms, and reduce the distortions that arose from previous price freezes...

Its first stage...[I]t included an increase in existing tax rates, such as income tax, the creation of new taxes, such as the tax on financial intermediation, and the renegotiation of subnational government debt in an attempt to control the deficits of subnational governments... a way to suspend part of the earmarked revenues of states and municipalities, providing more flexibility in the government budget. 

On the monetary side, a clearly stated intention to limit issuances of the new currency led to the adoption of a high interest rate policy and high reserve requirement ratios (100 percent reserve requirements on new deposits after July 1, 1994). In addition, the plan included changes in the institutional framework in which the central bank operated...

the government also reached an agreement on its external debt renegotiations under the Brady Plan, and in March 1994 its defaulted debt was securitized and the country regained access to international capital markets. 

Here is the really interesting part. Again, it is part of how to manage the transition especially with a lot of government regulation of wages and price setting. 

The Real Plan did not involve price freezes itself, but it was able to solve the problems of staggered wages and prices. Actually, this was considered the most controversial aspect of the plan but ended up being very successful. The creation of a new unit of account, the URV—Unidade Real de Valor (Unit of Real Value)—aimed at establishing a parallel unit of value to the cruzeiro real, the inflated currency. The idea was to make the unit temporary. Prices were quoted in both URVs and cruzeiros reais, but payments had to be made exclusively in cruzeiros reais. The URV worked like a shadow currency that had its parity to cruzeiro real constantly adjusted, since it was one-to-one with the dollar. Therefore, a conversion rate of the URV/cruzeiro novo (the old currency) was set every day, and many conversions were left to free negotiation between economic agents, with the government having more interference in oligopolized prices. That would allow agents to observe the low inflation of the parallel currency, therefore breaking the expectations of high inflation once the currency was changed. The URV was created in February 1994 when the Real Plan was officially launched, and in May 1994 the government announced that the real would become the new currency in July 1994. The government kept its plan, and the URV was extinguished on July 1, 1994, when it was converted to the new currency, the real, with the parity being 1 dollar = 1 real = 1 URV = 2,750 cruzeiros reais, and the adoption of a crawling-peg regime followed.

(Lest you think anything is new in monetary economics, François Velde has a great description of a similar dual currency scheme in 18th century France, though it is less clear why the French adopted that scheme.)  

After the currency conversion was implemented, inflation rates fell significantly, and the hyperinflation period in Brazil came to an end. Figure 21 illustrates how the increasing primary surplus since 1993 allowed the government to reduce its seigniorage revenues after the Real Plan was implemented.

However, in May/95–May/96, after inflation was under control and seigniorage revenues fell, the government showed a deterioration in its primary balance that would be reversed in the subsequent years. That fiscal deterioration was financed through domestic debt issuance, which shows that the credibility of the reforms played an important role, as it allowed the government to keep seigniorage revenues at low levels.

I'm not clear just why this one was credible and the previous ones were not. The authors are of the same view, I think

The success of the Real Plan in conquering the hyperinflation is indisputable, but many discussions have taken place regarding which were the most important points in accounting for it. ...One important condition was the availability of foreign financing, as foreign capital inflows resumed after the government reached an agreement with its foreign creditors under the Brady Plan. That was the end of a long process of foreign debt rescheduling. 

Yes but both are effects not causes

Another important factor was the fiscal reform that increased primary surpluses (figure 21). That reform also included other important fiscal measures that, most likely, did not have an immediate impact on government fiscal statistics. 

My emphasis. Expected future deficits / surpluses are always the key to inflations breaking out or stopping. 

Among those measures was the imposition of fiscal constraints on subnational governments... Finally, the tightness of monetary policy was an important characteristic of the Real Plan, and it still characterizes monetary policy to this day.

This is not the end of history. Of 1995-2016, the authors write

The last subperiod of our analysis represents the period of lowest inflation in Brazilian history. Inflation rates averaged only 8 percent per year, accompanied by the adoption of active fiscal and monetary policy rules. Economic growth resumed, but at moderate rates. Real GDP per capita grew 1.2 percent per year on average. 

That's not moderate, that's awful. Brazil should be growing like China. 

We also observed the process of fiscal consolidation, with primary surpluses in 1995–2002 and 2003–2011 averaging 2.3 and 2.8 percent of GDP, respectively... Despite all those advancements, the country experienced a big shift in its economic policy at the onset of the international financial crisis in 2008–2009, which eventually culminated in a rapid deterioration of its fiscal balances and a deep recession in recent years. These events have raised concerns about the capability of the government to maintain a low-inflation regime in the future.

Welcome to the club. 

The paper goes on to describe this period, but I have exhausted your patience already. There's a lot more in here to chew on, 

In theory, the maturity structure of debt, indexed vs. nominal debt, foreign and domestic currency debt make a big difference. Brazil has lots of variation there! 



  1. So, with the 'Real Plan' introduction of URV, a system of parallel currency was established to cover a transition period, which ended in July 1994. For any system of fixed parity, as with USD = 1 URV, to discover the correct "conversion rate" does take some transition time.
    I like to think about how the US Treasury/Congress might go about creating a parallel currency for the old USD? The IMF and SDRs are not the way to go, but some kind of UST currency board system might be interesting.

    You are correct to direct our vision toward the next decade in US fiscal policy. I have an adjustable rate mortgage and only Socialist Security to live on. It makes me worry.

  2. I've always wondered why countries like Brazil and India average 8 above rates of price inflation even during stable economic periods. Is the Central Bank the source? Buying up government debt and creating 8 percent increases in the money supply? And if so, why? Or is it driven by speculators?

    1. There is a lot of inertial inflation and an extremely indexed economy.

  3. Viewing the record for Brazil on the U.S. Federal Reserve Bank of St. Louis's FRED webpages, it is very clear that Brazil's monetary authorities have been very accommodative since January 1, 2000, in stark comparison to the U.S. FOMC, based on the relative compound annual growth rates of M3.

    For Brazil, the following 'stats' might be of some interest:

    --------- ---------- -------
    Q1 2000 - Q1 2014 3.53% 6.45% 13.6%
    Q1 2014 - Q4 2019 -0.55% 5.47% 3.4%
    Q4 2019 - Q4 2020 -1.24% 3.92% 54.2%

    And, Brazil M3 vs. USA M3 comparative compound annual growth rates (CAGR):
    JAN 2000 - JAN 2014 16.1% 6.37%
    JAN 2014 - MAY 2017 11.0% 6.05%
    MAY 2017 - OCT 2019 N/A 7.05%
    OCT 2019 - OCT 2020 N/A 23.7%

    Data for Brazil's M3 money aggregate measure is missing from June 2017 onwards.

    The explosion in liquidity in the USA as a result of the fiscal blowout during 2020 is clearly evident in the US M3 money aggregate measure. The price level must adjust, or the monetary authority must mop up the excess liquidity to contain the price level adjustment within acceptable bounds.

    Brazil's GDP growth rate in constant local currency units ("LCU") turned negative from Q1 2014 and remained essentially negative from then onwards. Nominal GDP growth rates remained positive from Q1 2014 onwards, leaving the impression locally that the economy hadn't been in recession. The cost of living however continued to rise in the mid to low single-digit percentum. With an increasing population, per capita incomes on a purchasing-power parity basis has been on
    a declining trend.

    In the USA's case, it will be interesting to watch the trend in CPI going forward. Will the significant jump in M3 influence the aggregate price level as the economy reopens and proceeds through 2022-25? I expect so.

    FRED econ data used to calculate the 'stats' posted above can be accessed by navigating to:

    The traces on the graph are quotients based on the individual curves' value as at January 01-2000 = 100.00. It makes visual comparison a little easier to make on the fly.

    1. Old Eagle Eye,

      Since you can't decide what drives inflation (expectations, monetary aggregates, the phase of the moon) what makes you think you can predict trends in it?

    2. This comment has been removed by the author.


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