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The Legacy of the Real Plan and an Alternative Agenda for the Brazilian Economy*

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The Legacy of the Real Plan and an Alternative Agenda for the Brazilian Economy* The legacy of the Real Plan and an alternative Agenda for the * Brazilian economy Fernando Ferrari-Filho** Luiz-Fernando de Paula*** The outstanding faults of the economic society in which we live are its failure to provide for full employment and its arbitrary and inequitable distribution of wealth and incomes John Maynard Keynes Abstract The Real Plan is considered the most successful plan of economic stabilization that the Brazilian economy has experienced recently in relation to the prime objective of reducing and controlling the country’s inflation rate. Although price stabilization represents the incontestable success of the Real Plan, it fails when we look at the poor performance of Brazilian economic activity throughout the period of real. This paper has two objectives. First, it aims at analyzing the reasons of successful – that is to say, the reduction and control of the inflation rate – and unsuccessful – low economic growth, high unemployment and macroeconomic instability (fiscal budget and balance of payments deficits) – of the Real Plan. In this context, the paper shows that the Brazilian stabilization policy, during the period of real, resulted in increasing the fiscal imbalances and balance of payments deficits. These disequilibria, as a consequence, impose some constraints concerning the recovery of Brazilian economic growth in the medium and long runs. Second, it presents an Economic Agenda able to control inflation and promote economic growth in Brazil in a sustainable path. Key words: Real Plan, Brazilian economy, stabilization plan. JEL Classification: E12, E63, E64. * This paper was presented at the Jornada da Sociedade de Economia Política, December 11-12, 2002, ANPEC Annual Meeting, Nova Friburgo, Brazil. The paper was written originally in May 2002. We are very grateful to Philip Arestis and two anonymous referees for many helpful comments on an early version of the paper. All remaining erros are, of course, our responsibility. ** Full Professor of Economics at the Federal University of Rio Grande do Sul and Research Fellow in Economics at CNPq, Brazil. E-mail: [email protected] *** Associate Professor of Economics at the University of the State of Rio de Janeiro and Research Fellow in Economics at CNPq, Brazil. E-mail: [email protected] 1 Introduction After many frustrated attempts at stabilization policies in Brazil during the 1980s and 1990s1, the Real Plan is considered the most successful plan of economic stabilization that the Brazilian economy has experienced recently in relation to the prime objective of reducing and controlling the country’s inflation rate. The inflation figures witness the success of the Real Plan: in June 1994, one month before the introduction of real as the legal tender, the annual inflation rate was around 5,150.00%, while in December 2001 the annual inflation rate was, approximately, 10.0%. Although price stabilization represents the incontestable success of the Real Plan, it fails when we look at the performance of Brazilian economic activity throughout the period of real: from 1994 to 2001, the average growth rate of GDP was only 2.8% per year, very similar to the average growth rate of GDP of the Brazilian economy in the 1980s – by the way, this period was considered as a ‘decade lost’ by Brazilian economists; the growth rate then was 2.9% per year2. This paper has two objectives. First, it aims at analyzing the legacy of the Real Plan: on the one hand, the inflation in Brazil was eliminated; on the other hand, the Brazilian economy became highly vulnerable due to its dependence upon foreign finance and the financial fragility of the domestic debt. In this context, the paper shows that the Brazilian stabilization policy, during the period of real, resulted in increasing the fiscal imbalances and balance of payments deficits. These disequilibria, as a consequence, impose some constraints concerning the recovery of Brazilian economic growth in the medium and long runs. Second, it presents, in the light of the Post Keynesian theory, an Economic Agenda, able to control inflation and promote economic growth in Brazil in a sustainable path. Going in this direction, besides this introduction, the paper contains four sections. It begins in section 2 by bringing back the logic and theoretical framework of the Real Plan. Section 3 shows the management, by monetary authorities, of economic policy during the period of real and its impact on real variables, before and after the Brazilian currency crisis, in January 1999. Further, it presents an interpretation of 1997-1999 Brazilian currency crises. Section 4 analyses if there are important changes in the macroeconomic constraints of the 1 Cruzado Plan in 1986, Bresser Plan in 1987, Verão Plan in 1989, and Collor Plan in 1990 are some examples of these frustrations. 2 These average growth rates of GDP were calculated according to Table 1. 2 Brazilian economy after the exchange rate devaluation in January 1999. The last section presents some policy recommendations able to restore the macroeconomic balances, indispensable to maintain the inflation under control and, at the same, achieve economic growth and social development in Brazil permanently. 2. The logic and theoretical framework of the Real Plan 2.1 Stabilization plan with exchange rate anchor and liberalization of the trade and capital accounts of the balance of payments: some stylized facts3 Experience with stabilization programs based on some kind of exchange anchor and the liberalization of the trade and capital accounts of the balance of payments shows that, generally speaking, such plans at first generate an abrupt drop in the rate of inflation, accompanied by marked appreciation in the exchange rate4. The local currency appreciates as a result of differential evolution by domestic and foreign prices in a context where the nominal rate of exchange remains stable, causing the balance of payments current account to contract substantially, due principally to the increase in the value of imports. Normally, the resulting deficit is accompanied by a large capital account surplus, thus not only enabling the former to be financed, but allowing the volume of the country’s international reserves to grow. The latter increase occurs as a result of the surge of foreign capital entering the country drawn by the stabilization plan’s initial success, combined generally with liberal structural reforms. Higher domestic interest rates, an added attraction to external financing, are normally used to reinforce these factors still further. Indeed, the defense of the exchange rate requires that monetary policy be devoted mainly to maintaining the exchange rate. The introduction of tight monetary policies and greater freedom for foreign investors create an interest rate differential sufficiently large to attract arbitrage capital inflows. The increasing influx of foreign capital, however, can lead to a still greater real appreciation of the exchange rate, leading to a further increase in imports and also a downturn in exports. On 3 This Section is partly based on Paula and Alves, Jr (2000, Section 1). 4 Dependence on foreign capital flows causes, among other problems, the real exchange rate to appreciate, non-tradables to expand at the cost of tradables, and trade deficits to increase, which can leave the country’s economy increasingly vulnerable to external factors. In this connection, see Gavin et al (1995) and Corbo and Hernandez (1996). 3 the other hand, the need to maintain high interest rates in order to attract foreign capital, and efforts to sterilize the inflow of foreign capital (also requiring high interest rates) lead to increasing public internal debt and also a deteriorating fiscal balance. In fact, sterilization of inflows is a potentially expensive strategy for the government due to the fact that the interest rate of the domestic bonds that the central bank sells is higher than the interest rate of the foreign bonds that the central bank buys. So, sterilization can create significant fiscal costs in financing high levels of reserve holdings depending on the scale of the operation and the size of the interest differential vis-à-vis external rates in reserve centers. (Cardoso and Goldfajn, 1998:165) In this context, a larger and growing current account deficit will only be sustainable if equivalent levels of long-term external funding are available, associated with productive investment capable of generating a future flow of exchange revenues sufficient to pay off outstanding debt. The precise nature of capital inflow is fundamentally very important, since one of the great perils of stabilization plans with exchange rate anchors is that a reversal in the flow of foreign capital can lead to a balance of payments disequilibrium of such a magnitude that it becomes unfeasible for the government to maintain the existing exchange rate5. Expectations for exchange rate devaluation are generated among international investors, leading in turn to further shrinkage in inflows of foreign capital and, consequently, a fall in levels of reserves, leaving the government no option but a substantial devaluation in the nominal exchange rate. This in turn may have a prejudicial effect on domestic prices and on the behavior of non-resident investors, thus jeopardizing partly the stabilization effort. Therefore, balance of payments disequilibrium results from the fact that, in a world of globally mobile financial and productive capital investments, domestic stabilization policies can be inherently destabilizing. This is because, under these conditions, the initially successful application of an internal stabilization policy may generate an endogenous process of deteriorating economic conditions (a growing public deficit, a growing deficit in its balance of payments current account and dependence on foreign capital, among others), 5 If expectations for exchange rate devaluation are generated among international investors, leading in turn to further shrinkage in inflows of foreign capital and, consequently, a fall in levels of reserves – that is to say, when speculative attack arises – the government strategy is just a substantial devaluation in the nominal exchange rate.
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