The Monetary and Fiscal History of Latin America: Brazil

Márcio GarciaPUC-Rio

The Monetary and Fiscal History of Latin America:A comparative case study using a common approach

April 11–12, 2014

Diogo GuillénGávea Investments

Patrick KehoeUniversity of Minnesota

INTRODUCTION

Brazilian Hyperinflation:Protracted and Resilient

• Lasted a decade • Why? Indexation made hyperinflation possible

without output collapse;• 5 failed attempts to stabilize;• The last attempt worked: Real Plan (July, 1994);• Inflation has been controlled for the last 2 decades;• Money and inflation: annual inflation rates are well

explained by static link with annual money growth.

Not Classic Sargent-Wallace Fiscal Dominant Stabilization

• Standard fiscal-driven-stabilization logic assumes that money printing ends when a large credible fiscal adjustment is made;

• Brazilian Real was not like that;• Money hyper-printing stopped in the Real Plan• But fiscal situation deteriorated markedly under this plan• Saw higher operational deficits (primary+real interest on debt)• Only five years after stabilization did fiscal stance improve;• Punchline: While fiscal stance eventually improved, there was

no “deliberate and drastic” fiscal measures associated with the end of the Brazilian hyperinflation.

• Is Brazil a Pro-Friedman, Anti-Sargent-Wallace case?

Brazilian Stabilization: Deindexation and Stop Money Printing

• Stabilization displays a close static link between money printing and inflation;

• The fiscal deterioration, from 1995 to 1999, somehow did not derail stabilization.

Plan of This Talk

• History of the Brazilian hyperinflation;• The 5 failed Stabilization attempts;• The Real Plan: Why did it work?• Because cut money growth;• Didn’t cut deficits;• Tight contemporaneous link between money

and inflation.

BRAZILIAN HYPERINFLATION: HISTORY

Source: Consumer Price Index (IPCA) from IBGE

Jan/85

May/85

Sep/85

Jan/8

6

May/86

Sep/86

Jan/8

7

May/87

Sep/87

Jan/8

8

May/88

Sep/88

Jan/8

9

May/89

Sep/89

Jan/9

0

May/90

Sep/90

Jan/91

May/91

Sep/91

Jan/9

2

May/92

Sep/92

Jan/9

3

May/93

Sep/93

Jan/9

4

May/94

Sep/94

Jan/9

5

May/95

Sep/95

Jan/9

6

May/96

Sep/96

Jan/9

7

May/97

Sep/97

Jan/9

8

May/98

Sep/98

Jan/9

9

May/99

Sep/99

0

1

2

3

4

5

6

7

8

9

10

BRAZIL: PRICE LEVEL (in log)Consumer Price Index (log(Jan, 1985)=1)

Cruzeiro

Bresser

Summer

Collor I

Collor II

Real

Source: Consumer Price Index (IPCA) from IBGE

Jan/8

5

May/85

Sep/85

Jan/8

6

May/86

Sep/86

Jan/8

7

May/87

Sep/87

Jan/8

8

May/88

Sep/88

Jan/8

9

May/89

Sep/89

Jan/9

0

May/90

Sep/90

Jan/9

1

May/91

Sep/91

Jan/92

May/92

Sep/92

Jan/9

3

May/93

Sep/93

Jan/9

4

May/94

Sep/94

Jan/9

5

May/95

Sep/95

Jan/9

6

May/96

Sep/96

Jan/9

7

May/97

Sep/97

Jan/9

8

May/98

Sep/98

Jan/99

May/99

Sep/99

0

1

2

3

4

5

6

7

8

9

10

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

BRAZIL: PRICE LEVEL (in log) and INFLATION (% per month)

Cruzeiro

Bresser

Summer

Collor I

Collor II

Real

Brazilian Hyperinflation

• Lasted much longer than classic hyperinflations.

Country Beginning End Pt/P0Av Monthly

Inflation Rate (%)Av Monthly M

Growth (%)

Austria Oct. 1921 Aug. 1922 70 47 31

Germany Aug. 1922 Nov. 1923 1x1010 322 314

Greece Nov. 1943 Nov. 1944 4.7x106 365 220Hungary 1 Mar. 1923 Feb. 1924 44 46 33

Hungary 2 Aug. 1945 Jul. 1946 3.8x1027 19800 12200Poland Jan. 1923 Jan. 1923 699 82 72Russsia Dec. 1921 Dec. 1921 1.2x105 57 49

Brazil Jan. 1983 Jun. 1994 1.4x1010 20 19

Classical Hyperinflations

Why Brazilian Hyperinflation Lasted So Long?

• Indexation makes possible to cope with hyperinflation;

• No collapse of GDP growth.

• Even during hyperinflation, no collapse of GDP growth

-10.00%

-8.00%

-6.00%

-4.00%

-2.00%

0.00%

2.00%

4.00%

6.00%

8.00%

10.00%

0.00%

500.00%

1000.00%

1500.00%

2000.00%

2500.00%

3000.00%

Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95

Annual Inflation and GDP Growth

Inflation

GDP Growth

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20130.00

500.00

1,000.00

1,500.00

2,000.00

2,500.00

3,000.00

-4.00

-2.00

0.00

2.00

4.00

6.00

8.00Annual Inflation and GDP growth

Annual Inflation GDP growth

% %

Why no collapse GDP growth: Indexation

• Started in late 60s;• Idea: isolate real economy from inflation;• Advocated by Milton Friedman;

o “2nd best to price stability”; • Mixed blessing:

– Easy to live with high inflation, but– Made inflation fight more difficult and politically

less desirable.• One of the reasons inflation lasted longer.

Why Didn’t Brazil Endogenously Dollarize

• In most other hyperinflation, agents gave up holding local currency and used dollars;

• Didn’t happen in Brazil because bank deposits were protected against inflation;

• To provide those inflation-protected deposits, banks held gov’t bonds that were either indexed to inflation or of very short maturity;

• Punchline: Brazil avoid dollarization by engineering a domestic substitute to its hyperinflated currency, i.e., a domestic currency substitute

How to Stop Printing Money?

• The Brazilian Central Bank could not raise much the real interest rate (passive monetary policy) or many banks would fail;

• So, money printing could not stop cold-turkey;• What made possible the end of passive monetary

policy was the end of indexation through the transformation of an indexed unit of account pegged to the US dollar (the URV, Real Unit of Value) in the new currency, the Real.

Inflation History from 1980

• 1980-85: Crawling towards hyperinflation;• 1985-94: Five failed plans

o 1986: Cruzadoo 1987: Bressero 1989: Summero 1990: Collor Io 1991: Collor II

• 1994: A successful plan: Real Plan

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%Ja

n-80

Jun-

80

Nov-

80

Apr-

81

Sep-

81

Feb-

82

Jul-8

2

Dec-

82

May

-83

Oct

-83

Mar

-84

Aug-

84

Jan-

85

Jun-

85

Nov-

85

Apr-

86

Sep-

86

Feb-

87

Jul-8

7

Dec-

87

May

-88

Oct

-88

Mar

-89

Aug-

89

Jan-

90

Jun-

90

Nov-

90

Apr-

91

Sep-

91

Feb-

92

Jul-9

2

Dec-

92

May

-93

Oct

-93

Mar

-94

Aug-

94

Jan-

95

Jun-

95

Monthly Inflation

Bresser

Collor IISummer

Collor I

Cruzado

Real

Monthly Inflation

Jan-85

Dec-85

Nov-86

Oct-87

Sep-88

Aug-89Jul-9

0Jun-91

May-92

Apr-93

Mar-94

Feb-95

Jan-96

Dec-96

Nov-97

Oct-98

Sep-99

Aug-00Jul-0

1Jun-02

May-03

Apr-04

Mar-05

Feb-06

Jan-07

Dec-07

Nov-08

Oct-09

Sep-10

Aug-11Jul-1

2Jun-13

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

Monthly Inflation%

CRZ

BR SC I C II REAL

THE PREVIOUS 5 FAILED PLANS

Five Failed Plans

• Many were ambitious … but all failed

Five Failed Plans

• Many were ambitious … but all failed.

• Main weakness: continued printing money

Details of the Five Failed Plans

Cruzado Plan (1986)

• Froze Prices and wages, but:– Wages were raised at the beginning of the plan;– If inflation>20%, wages automatically adjusted;

• Pegged exchange rate to $;• Changed currency (cut 3 zeros);• Forced interest rate conversion;• Ended Central Bank automatic finance;• No effective major change in fiscal policy;• In 10 months, back to double-digit monthly inflation.

Forced Interest Rate Conversion

• Existing contract: example – Suppose cruzeiro interest rate: 14% per month;– Borrowed 1000 cruzeiros just before the plan; – Owed 1,140 cruzeiros in one month.

• Under plan: – Forced conversion into cruzado contract;– 0% interest rate in new currency;– Now owe 1 cruzado in a month.

End of Central Bank automatic finance

• Before the plan:– Commercial government bank (Banco do Brasil)

gave subsidized loans to both private agents and the government;

– Central Bank printed money to cover subsidies.• Plan:

– Forbade this practice.

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%Ja

n-83

Apr-

83

Jul-8

3

Oct

-83

Jan-

84

Apr-

84

Jul-8

4

Oct

-84

Jan-

85

Apr-

85

Jul-8

5

Oct

-85

Jan-

86

Apr-

86

Jul-8

6

Oct

-86

Jan-

87

Apr-

87

Jul-8

7

Oct

-87

Jan-

88

Apr-

88

Jul-8

8

Oct

-88

Jan-

89

Apr-

89

Jul-8

9

Oct

-89

Jan-

90

Apr-

90

Jul-9

0

Oct

-90

Jan-

91

Apr-

91

Jul-9

1

Oct

-91

Jan-

92

Apr-

92

Jul-9

2

Monthly Inflation

Bresser

Collor IISummer

Collor I

Cruzado

Monthly Inflation

Bresser Plan (1987)

• Froze prices;• Adjusted wages based on the average of the

three previous months;• Raise real interest rates to a positive value;• Fiscal: intended to keep nominal deficit to 3.7%, but actual nominal deficit was 33%.• In 3 months, back to double digit monthly

inflation.

New Constitution (1988)

• Worsened fiscal situation and made harder to adjust labor and spending:– Increased expenditures and transfers from the

central government to states and municipalities; – Reduced work week from 48 to 44 hours;– Increased firing costs and overtime compensation;– Earmarked revenues.

Summer Plan (1989)

• New Constitution 1988;• Froze prices (designed to last 4 to 8 weeks);• New currency: cruzado novo (cut 3 zeros);• Fixed exchange rate (1 Cruzado Novo = US$1);• De-indexed prices;• Ambitious fiscal and monetary reform:

– Congress refused.

Collor I Plan (1990)

• Froze Prices and Wages;• New Currency: Cruzeiro;• Monetary Component:

– Suspension of convertibility of 80% of all financial assets for 18 months.

• Fiscal Component:– Ambitious fiscal plan:

• Privatizations: some succeeded.• Other fiscal reforms: short-lived.

Collor II Plan (1991)

• Froze Prices;• Fixed exchange rate;• Opens up the economy;• Fiscal:

– reduce government expenditures:• firing civil servants (many got reinstated in courts);• closing public services (many reopened);• privatization of state owned enterprises.

THE REAL PLAN: WHY DID IT WORK?

Why the Real Plan worked• Because stopped printing money;• NOT because of credible fiscal reform;• In fact, fiscal policy got worse during first 5

years of the plan; • Consistent with Friedman;• Not consistent with Sargent Wallace fiscal

dominant regime;• Is consistent with SW money dominant regime;• Tight money now means low inflation now.

Jan-85

Dec-85

Nov-86

Oct-87

Sep-88

Aug-89Jul-9

0Jun-91

May-92

Apr-93

Mar-94

Feb-95

Jan-96

Dec-96

Nov-97

Oct-98

Sep-99

Aug-00Jul-0

1Jun-02

May-03

Apr-04

Mar-05

Feb-06

Jan-07

Dec-07

Nov-08

Oct-09

Sep-10

Aug-11Jul-1

2Jun-13

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

Monthly Inflation%

CRZ

BR SC I C II REAL

TIGHT CONTEMPORANEOUS LINK BETWEEN MONEY AND INFLATION

• Money growth and inflation graph (annual tracks)-500.00%

0.00%

500.00%

1000.00%

1500.00%

2000.00%

2500.00%

3000.00%

3500.00%

Jan-80 Jan-81 Jan-82 Jan-83 Jan-84 Jan-85 Jan-86 Jan-87 Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95

Annual Inflation and Money Growth

Inflation

Monthly growth of M0

19831984

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20130.00%

500.00%

1000.00%

1500.00%

2000.00%

2500.00%

3000.00%

Annual Inflation and Money Growth

Money Growth Annual Inflation

CRZ C IC II REALBR S

• Money growth and inflation (monthly dances)

0.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%Ja

n-80

Jun-

80

Nov-8

0

Apr-8

1

Sep-

81

Feb-

82

Jul-8

2

Dec-8

2

May

-83

Oct

-83

Mar

-84

Aug-8

4

Jan-

85

Jun-

85

Nov-8

5

Apr-8

6

Sep-

86

Feb-

87

Jul-8

7

Dec-8

7

May

-88

Oct

-88

Mar

-89

Aug-8

9

Jan-

90

Jun-

90

Nov-9

0

Apr-9

1

Sep-

91

Feb-

92

Jul-9

2

Dec-9

2

May

-93

Oct

-93

Mar

-94

Aug-9

4

Jan-

95

Jun-

95

Monthly Inflation and Monthly Growth of M0 (5 month moving average)

BresserCollor IISummer

Collor I

Cruzado

Real

Inflation Monthly growth of M0

10.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

80.00%

90.00%

100.00%

Monthly Inflation and Monthly Growth of M0 (5 month moving average)

Monthly Growth of M0 Monthly Inflation

CRZ BR S C I C II REAL

Fiscal Improvement Pre-RealFiscal Deterioration Under Real

-2.5

-0.5

1.5

3.5

5.5

7.5

5.1

0.038

3.866

0.44

1.336

-0.365

3.7 3.94

0.68 0.5 0.600514484405486 0.507284096473275

PSBR - Operational Seigniorage 5yr Average - PSBR Operational 5yr Average - Seigniorage

CRZ

BR CR I

CR II

S REAL

19851986

19871988

19891990

19911992

19931994

19951996

19971998

19992000

20012002

20032004

20052006

20072008

20092010

20112012

20130%

500%

1000%

1500%

2000%

2500%

3000%

Annual Money Growth and Inflation

Annual M Growth Annual Inflation

CRZ BR S C IC II

REAL

Public Debt Increased Under Real Plan

1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

-20.00

-10.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00BRAZIL : PUBLIC NET DEBT

Public Foreign Net Debt Public Domestic Net Debt Public Total Net Debt

(% GDP)

CRZB RS

C1C2

Real Plan

• Ingenious mechanism (URV) to get relative prices “right” in the new currency, the real;

• Exchange rate ceiling: 1 real = 1 dollar:– Given high interest rates, capital flew in and parity to

dollar became credible, serving as a nominal anchor;• Fiscal:

– Suspension of part of earmarked transfers to states and municipalities to get fiscal surpluses;

– Extra taxes on financial intermediaries;

THE URV (became the Real)

• Real Unit of Value: 1 URV = 1 US$;• March-June 94: new unit of account with

stable purchasing power;• Labeled prices in both URV and cruzeiro real;• Idea:

o Paid for goods only in cruzeiro real;o Prices in unit of account URV were stable;o Replaced URV with real on July 1, 1994.

Conclusion• In the Brazilian hyperinflation experience, the link between

inflation (and, therefore, seignorage) and money growth is contemporaneous;

• On the other hand, fiscal improvements in the early 90s did not help on the inflation front, until the 94 Real Plan, while the marked deterioration of the fiscal stance from 95 to 99 did not derail stabilization.

• Friedman-like monetary dominant regime fits data better than fiscal dominant regime as in “unpleasant arithmetic” or “end of 4 big inflations”.