The inflationary process in Brazil and its relations with the public sector deficit and debt

ABSTRACT

This paper offers an interpretation of the Brazilian inflation and comments briefly on the Cruzado Plan. It emphasizes two points. First, there are the problems of fiscal consolidation in the presence of a large public debt. What is missed in many analyses of stabilization programs is precisely the particular debt situation, and the role of foreign exchange availability in successful versus non-successful programs. Secondly, we discuss the role of budget deficits in the inflationary process in Brazil. Seignorage models as an explanation for inflation in Brazil are dismissed on the grounds that seignorage as a share of GDP shows absolutely no correlation with inflation. The money-goods model of monetarism is inappropriate for the Brazilian economy because it predicts that seignorage drives the system. But the Brazilian experience on the contrary has to be interpreted in the light of changing sources of financing the budget. The inflation acceleration between 1979 and 1985 is linked to the switch from external to domestic finance, and the large trade surpluses that pushed up interest rates and inflation. The paper develops a model that shows a pattern of adjustment for increasing inflation induced by increasing equilibrium real interest rates, that matches the Brazilian data. The Cruzado Plan failed to pay attention to the debt problem and the need for budget consolidation (probably through debt relief and a capital levy). In the absence of an integrated approach, it pushed the economy into a classic inflationary finance situation.

KEYWORDS:
Inflation; stabilization; Cruzado Plan; debt