Brazil's current conditions
Bank of New York
Causes of Current Conditions
Debt
Brazil was a major importer of oil when the oil shocks of the 1970's took place. Domestic price increases for oil did not come at the same time as the external deficits caused by the higher prices. The lack of adjustment led Brazil to finance, using the debt market. After the first oil shock, Brazil might have had a chance to recover. However, when the second oil shock hit the damage became long term as Brazil went farther into debt. With full domestic indexation of wages and the exchange rate, oil price increases became wage increases. The wage increases turned into another and higher round of price inflation. This effect seen by using the wage-setting and price-setting curves, shows that the higher the markup, the lower the real wage will be, implied by price-setting. The graph below shows the lower price-setting line and the adjustment of the wage setting line.
P = Pe ( 1 + µ ) F ( 1 – Y / L , z )
Using the AS/AD model, we can follow the order of events. The increase in the price of oil, the markup, will lead firms to increase their prices, leading to an increase in the price level, P, at any level of output, Y. This causes the aggregate supply curve to shift up. The aggregate demand curve may shift as a result. The higher price of oil may lead firms to change investment plans. The increase in the price of oil also redistributes income from oil buyers to oil producers. Some of these effects will shift the aggregate demand curve to the right and some will shift it to the left. To simplify our example we have made the effects cancel each other out, thus the aggregate demand curve does not move. The graph below shows the moves up of the AS curve and it shows how the AD curve will adjust so that it returns to its natural state.
Stabilization and Reform
Plan after plan has been implemented to stop inflation. Unfortunately, another round of increasingly worse inflation has followed each plan. Most of the plans introduced new money and all of the plans had a name: Cruzado, Cruzado II, Plan Bresser, Summer Plan, Collor Plan, Collor II, and finally the Real Plan, which is currently in place.
The Real Plan
Of all plans attempted, the most successful economic stabilization program is known as the Real Plan.
The Real Plan was established to attain:
1. “Deindexation” of the economy through the use of the URV
2. A gradual approach to the monetary reform;
3. Appreciation of the currency.
The main concern of the plan is to deal with Brazil’s problem with high inflation. The Real Plan was put into use in 1994. The plan was first to deal with factors causing a strong indexation, leading to ongoing inflation. [next page]