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Plano Real
The Latin American Economy
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Classical Hyperinflation
The pattern of a classical hyperinflation
is an acute acceleration of inflation rates
until reaching extremely high levels.
Also typical: rapid substitution away
from domestic currency (e.g.
dollarization).
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Monthly Inflation Brazil
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This shows that despite high levels of
inflation before plano Real, Brazilian
inflation was not killed and did not showclassical explosive hyperinflation.
Next table also show that Brazil
exhibited surprised resilience to highlevels of inflations
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Brazil: Real GDP growth and
Inflation
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Two key elements played a role
differentiating Brazil from the classicalhyperinflation experience:
(1) Indexation
(2) Provision of a domestic currency
substitute (i.e. interest paying asset with
near money liquidity).
This second element was the main
source of Brazilian central bank inabilityto fight inflation and the unwillingness of
Brazilians to face the costs of such a
fight.
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Main reasons to Brazilian
Hyperinflation1. Fiscal Imbalances Sizable fiscal
deficits were created (conflict of federalism
between dictatorship and democracy)2. Indexation Brazil had a strong
indexation scheme, prices, wages, taxes,
exchange rate, public and private debt,
Indexation made inflation expectation
backward looking and increased
substantially the sacrifice ratio
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Strategies to Fight Inflation
1. Wage and prices freezes
(Cruzado Plan)
2. Set exchange rate, public sectorprices and oligopolistic sector prices to
a slowly decline path (Delfim Plan)
Both heterodox plans
3. Monetary Reform (budget balance,
etc)
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Real Plan
Real Plan started at 1993 and it was divided
in three stages:
1. Budget balancing 3 months of negotiation2. Introduction of URV - 4 months
3. New currency implementation - Real
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Budget Balancing
Budget balancing before the introduction
of the new currency
showing that government could put in
practice its budget expenses without
seignorage
Government kept with many reforms after
the real privatization of SOE, privatization of State
Banks, trade liberalization
Tight monetary policy
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URV
URV - unit of real value (orUnidadeReal de Valor)
Domestic unit of account with a virtualexchange rate
1 URV ~ 1 dollar
The URV would be adjusted daily by theCentral Bank to keep its real value
(adjust to compensate inflation)
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URV
All prices and contracts were slowlyconverted to multiples of URVs
Once all contracts were converted toURV the government would start issuinga new currency: the real
The goal of the URV was to indexcompletely the Brazilian economy to theURV: keep relative prices stable
Worked as a Nominal anchor.
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Why not simple adopt a
nominal anchor right way?
Brazilian economy was highly indexed,
however different contracts had differentperiodic adjustment clauses
It would create dispersion of relative real
prices with some prices that were recently
adjusted higher than others
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Why not simple adopt a
nominal anchor right way? Sudden stops of inflation (as done
during Cruzado Plan) would have such
problem: some prices at the peak andothers at the bottom --> generatinginflation pressure
This is an important component of theinertia behind Brazilian inflation
URV allowed prices to be fully aligned
(during 4 months), avoiding the problems
of sudden stop
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1 Real = 2750 Cruzeiros Reais
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REAL 1 month noticed was given previous to the
monetary conversion rate (1 URV=1 real)
After four months the government launched
the new currency real The value of 1 real would not be allowed to
cost more than one dollar (upper bar in theexchange rate)
Once the exchange rate reach close to 1 real= 1 dollar, the CB committed to sell dollars
All the contract that were set in real term atURV became fixed in nominal terms real
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Plano Cruzado
Drastic measures
against inflation
New currency Annual adjust of
rents and mortgages
Prices will be frozen
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News at the
time: Start the war
Real X Inflation
It was word cup time
(We won ),
Maradonna was
caught on drugs
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Why the plano real was
successful while others failed?
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Why the plano real was
successful while others failed? We won the 1994 World Cup!
Not really.
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Why the plano real was
successful while others failed? We won the 1994 World Cup!
Not really. But it can be argued it played a
role.
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Why the plano real was
successful while others failed? Series of reforms:
Contractionary fiscal and monetarypolicies, increased interest rates
(increasing foreign reserves)
Strong focus on balance of payments
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Annually Inflation and Money Supply Growth