Chega de Saudade: Explaining the Return of Brazilian Inflation

• In Event: Macroeconomía y Desarrollo

Abstract

To fight hyperinflation, successive Brazilian governments devised economic plans seeking to tame it with a variety of strategies involving both monetary and fiscal reforms. The sole plan that succeeded was the Real Plan, which involved a careful monetary reform on top of broader institutional reforms including commercial liberalization and privatization. Amongst the reforms introduced with the Real Plan, there were the creation of a financial transactions’ tax, as well as an explicit restriction on a significant proportion (20%) of Federal expenses. Following a foreign shock the monetary policy mix changed from a controlled exchange rate towards a system of inflation targeting, flexible exchange rate, and interests’ rates definition by the Central Bank. Despite this policy mix that seemed to work well during the 2000s, inflation came back in the 2010s, albeit not as high as in the late 1980s and early 1990s. What went wrong? The hypothesis of the present paper is that some elements of the Real Plan such as the financial transactions’ tax granted to the Federal Government a bigger proportion of the country’s resources allowing it to pay for mandatory expenses. When this tax disappeared the Federal Government lost this source of revenue, which was substituted by inflation. The fact that inflation returned, despite the overwhelming institutional transformations implemented with the Real Plan, suggests that Brazilian inflation is not exclusively a monetary issue but a more complex consequence of a series of fiscal arrangements. The latter, with its political implications, have not changed as much as the monetary policy mix.

Author

• Alejandro Angel Tapias, Université de Montréal