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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