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What is Balance of P. or are being maintained only by a level of foreign borrowing. C. it has difficulty maintaining a fixed exchange rate. This means that foreign exchange reserves are falling rapidly. ultimately facing a balance of payments crisis. When a country that has a large budget deficit. .
.“Four Zones of Economic Discomfort” Brazil has been located in Zone 3 for many years. with varying degrees of underemployment and current account deficits.
000% per year (1984-1994). .Inflation dropped from an annual rate of 2.Brazil in the 1990s After a decade of inflation rates ranging from 100% .669% in 1994 to 10% in 1997 1994 – Brazil government reissued the „real‟ and instituted a crawling peg ○ The real was initially pegged to the US Dollar.3. . Brazil‟s central bank made an effort during the 1990s to control inflation and public spending. which allowed Brazil‟s currency to crawl upward against the $ at a moderate rate.
.there were bank failures and unemployment all over the country. The real now faced real appreciation. combined with high interest rates stabilized inflation for the first time in decades but… . investors dumped money into the Brazilian economy at extraordinary rates.Brazil in the 1990s (cont) The new currency. ○ The rate of crawl of the exchange rate < (Brazilian inflation – Foreign inflation) . Due to high interest rates. Unemployment climbed from a low 6% in 1988 to 14% a decade later.
Foreign direct investment (FDI) grew by 140% over the year before.Brazil in the 1990s (cont) 1997 . . The table below shows the rapid increase in FDI and international reserves.
○ In an effort to slow the outward flow of capital. Brazil‟s international reserves dropped by $24 billion or 40%. . the central bank raised interest rates. ○ Between 1996 and 1998. The IMF (International Monetary Fund) provided a $41. Over the previous two years (98-99) the central bank was able to use its foreign exchange reserves to prevent the currency from drastically depreciating. ○ But markets remained hopeless and the plan failed.Brazil in the 1990s (cont) 1998 .Investors expected Brazil‟s central bank to eventually devalue the real.5 billion loan in 1998 to help Brazil defend its currency.
As seen in the table below. . Brazil started depleting its reserves in 1997 and 1998 to finance the current account deficit.Current Account & Reserves In addition. Brazil was running consistent current account deficits starting in 1995.
Brazil in the 1990s (cont) 1999 . January 1999 . dollar.The central bank decided to devalue the real by 8% and allowed it to float so it would no longer be pegged to the U.S. and unemployment reached its highest level in over a decade.Brazil owed $244 billion (46% of GDP) to foreign creditors. Brazil‟s yearly governmental budget deficits remained in the 67% range throughout the 1990s. the real depreciated 66% against the U. exchange rate reserves were declining. By the end of the month. .S. The current account was in deficit. dollar. Despite efforts to raise taxes and control government spending.
recession followed as Brazil‟s government struggled to keep the real from losing its worth.Devaluation of the real Soon after the real depreciated its value. ○ Increase in the money supply ○ Increase in reserves ○ Interest rates lowered . Luckily. The recession diminished as Brazil‟s export competitiveness was renewed and investors slowed their withdrawal from the real. resulting in. inflation did not rise.
O.P. rapid expanding current account deficit constant government spending The Russian Financial Crisis in 1998 ○ Russia‟s 1998 default on its debt had international investors in panic. . investors had good reason to believe that the central bank could no longer maintain the crawling peg. In all. crisis model is the best way to analyze Brazil‟s devaluation. The B.Waiting to happen Brazil‟s actual economic data leading up to the devaluation is consistent with the balance of payments crisis model. Investors that previously had confidence in Brazil‟s economy suddenly lost faith in the government‟s ability to maintain the real’s crawling peg.
The DD-AA Model .
In addition to building reserves. .The DD-AA Model This model assumes an initial starting point at full employment (point 1). however. With IMF support it is possible that Brazil could have avoided devaluation. with an unemployment rate above 14% in 1997 and 1998. the central bank may have hoped that the devaluation would increase output to full employment levels. it is likely that Brazil‟s output was well below full employment.
. ○ Which makes it difficult to revert back to a fixed rate system that only functions if investors trust the central bank and become less risk averse. The devaluation also tensed relations with neighboring countries like Argentina who are deeply affected by Brazil‟s economic policy.The Aftermath While currency devaluation might help a country improve its CA deficits and return the economy to full employment. dollars was instantly increased with the depreciation. On the positive side. there are some negative aspects. Once the real was devalued. each year since the devaluation. the central bank lost its credibility and had little choice but to form some sort of floating rate. the current account has improved and in 2003 it was positive for the first time since the early 1990s. Brazil‟s large public debt held in U.S.
the government will now be tempted to print money freely in order to pay off debt. . Instead the Brazilian government must control its public debt and budget deficit spending. it‟s obvious that a fixed exchange rate was not the only cause of Brazil‟s economic woes of the 1990s. nor is a floating exchange rate going to fix all of Brazil‟s economic issues. Inflation is the primary reason that Brazil adopted a crawling peg in the first place. Under this floating rate system.Conclusion Looking at Latin America‟s unstable economic history.
the country has taken steps toward more stable economic policy. the 2004 budget deficit was at a low 3% of GDP. Brazilians can only hope that these policies lead to economic growth for Latin America‟s largest economy. Brazil has also managed to keep their exchange rate under control. . In 2005 foreign debt was at its lowest point since 1997 In addition.Conclusion Recently Brazil‟s government has taken spending more seriously. ○ Low inflation ○ disciplined fiscal policy ○ a floating exchange rate Although Brazil still has budget deficits and owes a sizeable amount to creditors.