Transcript Brazil's 1998-1999 BOP Crisis

Brazil's 1998-1999 BOP Crisis
Inflation: The Root of the Problem
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1980- Runaway inflation was ranging
from 100% to 3,000% a year.
Introduction of Real
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1994-Real is introduced. Was intended to go up
against the dollar. It was set up in the way that
it could depreciate at controlled rate against the
dollar.
High interest rates were created and were
intended to fight the high inflation by reducing
an incentive to hold money.
Introduction of Real Cont.
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1980-1994- Real experiences an appreciation
which makes it undesirable in the foreign
market. Therefore: the interests rates go up
causing bank failures and unemployment.
Inflation is still 2,669%
Rise of National Debt
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1995- Consistent current account deficits begin
CA deficit reached 4.2% of GDP in 1998
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1997- Foreign direct investment grew by 140%
over the year before due to high interest rates
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Inflation is down to 10% There is still high
fiscal deficit.
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Perhaps, interest rates were high due to the
government repayment of its debt. (Brazil was
trying to finance its current account).
Are We There Yet?
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1998-Unemployment rose to 14% from 6%. Interest rates
went up while foreign reserves declined. Brazil’s high
spending discouraged foreign investors.
IMF injected $40 billion in economy.
(not certain what triggered foreign investors’ change in
response. Could be the reaction from the Russian financial
crisis or the realization of the current account deficiency).
Devaluation of Real
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1999- Brazil devaluates Real by 8% Real’s value
continues to loose value down to 40%.
Recession occurs due to the government’s
attempt to correct the fall of the currency.
Expectations of the fall of Real
There is a current
account deficit due to
the increase in
government
spending. So the
investors expect
devaluation in the
domestic currency.
Therefore there is an
upward shift of
foreign returns curve.
Ineffectiveness of Sterilization
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In order for sterilization to be effective there should be
a change in exchange rate. When fiscal policy
expanding, the central bank has to buy foreign assets
and increase the money supply to keep the exchange
rate constant. Perhaps, increasing money supply leads
directly to inflation. So, the other choice the
government has is to sell domestic assets to decrease
the money supply, but in turn it has to buy foreign
assets to keep the foreign exchange rate constant.
Inflation cycle is created as the result making this policy
an effective.
Citations
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www.haver.com
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http://www-personal.umich.edu/~kathrynd/Brazil.w06.pdf