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Inertial Inflation and the Cruzado Plan

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Inertial Inflation and the Cruzado Plan World Development, Vol. 15, No. 8, pp. 1035-1044, 1987. 0305-750X/87 $3.00 + 0.00 Printcd in Great Britain. © 1987 Pergamon Journals Ltd. Inertial Inflation and the Cruzado Plan LUIZ BRESSER PEREIRA* Fundacao Getulio Vargas, São Paulo, Brazil Summary. - On 28 January 1986 the Brazilian government decided to freeze ali prices. This article examines the "heterodox shock" and the dcveloprnent by Brazilian economists of the thcory of incrtial inflation, which scrvcd as a thcorctical basis for the shock. 1. INTRODUCTION inflation underwent a new acceleration, after a partia! price freezc from April to July, which On 28 February 1986, Brazilian inflation, artificially maintained it at an annual levei of which was already at a levei of approximately 150%. Inflation jumped from 270% a year 350'10 per annum, was halted by a heterodox (almost 12% a month) to a new annual levei of shock, that is, by a freeze in prices, wages, and about 360% (almost 13.5% per month), as can be the exchange rate. This sarne phenomenon had seen in Table 1. taken place in Argentina nine months earlier. ln both cases the economic policy adopted was Table 1. Annualized inflation derived directly from a new development of the Latin American structuralist theory of inflation: Periods IPCA* IGPt the theory of inertial inflation. In both cases we witnessed an important advance in the think- ing on economic policy accornpanied by a Dec. 1984-!Vlar. 1985 275.8 268.8 corresponding development in rnacroeconomic Apr. 1985-Jul. 1985 155.8 149.6 Aug. 1985-Jan. 1986 305.3 334.4 theory. Based on these experiences anti 011 the Nov. 1985-Jan. 1986 360.2 453.7 theory of autonomous or inertial inflation which preceded them, it is here maintained that ortho- dox economists - monetarists as wcll as Keyne- Source: FIBGE and Getulio Vargas Foundation. *IPCA = Consumer Pricc Index, sians - should rethink their models and give tlGP = General Pricc Index. more importancc to administrative policies for stabilizing prices .. The objective of this article is to make a When, in January 1985, monthly inflation general analysis, right after the Brazilian (Consumer Price Index - IPCA) reached Stabilization Plan, of the shock itself, of the 16.2%, and in February 14.3%, the situation theory on which. it was base d, and of its pros- became unbearable. The economic authorities pects. and the President of the Republic quickly Iearnt When this article was written, one month after ali they could about the theory of inertial the Brazilian heterodox shock, everything inflation which some Brazilian economists had seemed to indicate that inflation would be developed at the beginning of the 1980s. They brought under control. If this prediction is also noted the success of the monetary reforms confirmed, and the 1,000% inflation in Argen- and general price, wage and exchange rate freeze tina and the 350% inflation in Brazil are elimin- in Argentina and in Israel. It became increasingly ated with almost no cost, economic theory and clear that the only way to eliminate Brazilian policy - via the theory of inertial inflation - will inertial inflation would be a general prize freeze have taken a great step forward. and a monetary reform, or, in other words, a heterodox shock. The decision to carry it out on 2. THE ST ABILIZA TION PLAN "Since wnnng this article , Dr. Bresser Pereira has ln the second semester of 1985, Brazilian become Finance Minister of Brazil. 1035 1036 W O R LD D E V E LO PM E N T 28 February was hastened by the high inflation De-indexation was not total, thus maintaining rates of January and February. certain guarantees for economic agents. Mone- The basic measures of the Stabilization Plan tary correction was kept on deposits in savings consisted of: (1) freezing ali prices, wages, and accounts. The ORTNs (Readjustable National the exchange rate on D day; (2) de-indexing the Treasury Bonds), which served as a base for the economy; (3) introducing a new currency, the whole indexation process, were transformed into Cruzado, in place of the Cruzeiro, from which OTNs (National Treasury Bonds), but they kept three zeros were removed; and ( 4) converting ali a guarantee of a yearly correction. A "trigger term contracts (wages, debts, rents, school tui- price adjustrnent" was established for wages, tions, mortgage payments) from Cruzeiros to guaranteeing that they will be readjusted when- Cruzados via formulas which would guarantee ever cumula tive inflation reaches 20%. At the the recomposition of the average real price of the last minute, due to pressure from the workers, it last six months. Ali other stipulations of the Plan was also established that, in the respective annual complemented or established exceptions to these data base for wage negotiations, each category of four basic guidelines. workers would have its wages readjusted by 60% lt was a general frecze accompanicd by the of the past inflation, even if the "trigger" of the setting of prices for thc most important consumar ' movable scale is not reached. goods (almost 500 articles, with prices differcnti- ated according to geographic regions). The prices 3. WHY A HETERODOX SHOCK? wcre controlled formally by professional inspec- . tors and informally by the whole population. The success of the program dcpends mainly on Wages could not be directly converted frorn one condition: that on D day, 28 February, the Cruzeiros to Cruzados due to the different frceze does not provoke the emergence of any months in which wage readjustments were legally big winners or big losers. ln other words, rela tive executed. They could also not be readjusted to prices should be reasonably adjusted, without thcir pcak real value on D day by incrcasing any distortions causcd by partia! freezes and nominal wages by IOO'Yo of the period's inflation subsidies. Aside from this, thc time lags in the and then be converted into Cruzados, because, in increases should be small enough so that, on this dealing with a term contract , this would imply an D day, rela tive prices are not unbalanced be- increasc in the real wages of thc workers. lt ca use thc last rcadjustmcnt was closer or Iarthcr would have made thc freeze inviable for thc firms frorn the D day. as it would have eliminated their profits. The If there are big winners and big losers, this will solution was a simple conversion table for wages mean that the reform did not respect the law of and benefits received in the last six months into value; that market prices deviated too much frorn Cruzados in a way which guaranteed the re- production prices; that relative ~rkes were dis- constitution of average real wages and therefore torted benefiting those who had increased their of workers' buying power. Monthly wages rcceived prices recently and penalizing those who had during the Septernber 1985 and February 1986 planned to raise their prices soon after D day; period were multiplied by corrective coefficients that the differences between the sectoral profit which transformed them into real wages in terms rates incrcased rather than dccreased; and that of 28 February prices, totaled, and then divided by wages and other time contracts were not con- six to obtain the average real wage. An 8% bonus verted according to their average real values. If was added on to this amount. this happens, the pressure from losers could As in Argentina, another table was established prove unbearable. Their prices will have to be to reduce the value of term contracts in general. readjusted sooner or !ater, and the stabilization Corporations had included their expectations for program will be a failure. future inflation in the prices for ali term sales. Contrary to what happened in Hungary in Once prices were stabilized, it became necessary 1946, and in Argentina and Israel in 1985, there to guarantee a discount for debtors which corres- were no adjustments made in relative prices on ponded to these inflationary expectations. The the eve of D day in Brazil. Prices of state daily table for converting Cruzeiros into Cruza- corporations were not increased because it was dos established this discount, corresponding to thought, perhaps a bit hastily, that most of them the geometric average of inflation in the last had already been adjusted, and because it was thrce months before the shock ( 14.65%, ). Spccial wrongly predictcd that there would be no oper- formulas for conversion were establishcd for ational public deficit in 1986. The Cruzeiro, on rents, mortgages and school tuitions, ali of which the other hand, was not devalued before being attempt to reestablish the average real value of converted into Cruzados, and therefore no safety the contracts. margin was established in relation to the ex- INERTIAL INFLATION AND THE CRUZADO PLAN 1037 change rate w hich w ould allow for a srnall price freeze and on administrative measures arnount of inflation in the follow ing rnonths. instead of market rneasurcs to cornbat inflation. The predicted fiscal balance carne, on the one It is also heterodox because it does not provoke a hand, frorn a fiscal reforrn approved at the end of recession. An orthodox shock begins frorn the 1985, w hich increased the tax base progressively, assumption that economic agents spend more and, on the other, frorn the Stabilization Plan, than they earn. For this reason it would be w hich elirninated the real loss of taxes w hich necessary to provoke a recession which would carne frorn the difference between the rnom ent in reduce spending. The heterodox shock already w hich taxes are cornputed and w hen they are recognizes that the market no longer functions - paid.
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