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Brazil Fiscal Deficits and Inflation
The root of Brazilian inflation has been the monetization of the
public sector's fiscal deficit, because deficits that are not financed
by borrowing either from abroad or domestically must be covered
by the creation of money. By the early 1990s, the old debate between
the monetarists (see Glossary), who emphasized the central role
of money supply growth in the inflationary process, and the structuralists
(see Glossary), who attributed price increases to supply problems
in developing economies like Brazil's, was viewed as an obsolete
and largely sterile discussion. Instead, debate focused on the causal
relationship between inflation and the money supply, and on how
much freedom the government actually had in determining money-supply
growth.
However important monetization of the public sector's fiscal deficit
may have been in the past in either initiating or accelerating inflation,
the reinforcement of the inflationary process by past inflation
and by expectations of future inflation was an important part of
the Brazilian experience in the 1980s and 1990s. In Brazil the feedback
effect of past inflation has been institutionalized in an extensive
indexation or "monetary correction" (correção
monetária ) system, which was developed and extended to most
markets between 1964 and 1970. The result was an economy in which
apparently modest initial shocks could be transformed into high
and continuing inflation. Recognition of this feedback effect in
the early 1980s played a role in the design of the 1986 Cruzado
Plan, as well as in subsequent stabilization attempts, notably the
Real Plan in 1994. The inflation indexation system, which in the
1970s had been virtually unquestioned, was increasingly blamed for
contributing to the continuation and acceleration of inflation in
the 1980s and early 1990s.
Although inflation accelerated significantly in the 1980s, it had
long been a feature of Brazil's economy. The first major inflationary
surge began in the late 1950s and continued until 1964, in part
the result of the monetary accommodation of fiscal pressures resulting
from a sharp rise in government expenditures. A second surge began
in the 1970s, partly as a result of the external shocks caused by
the rise in energy prices. The indexation system served as a vehicle
for amplifying energy price increases into higher widespread price
increases than might have occurred. Inflation worsened dramatically
in the 1980s, however, as Brazil lost its access to foreign capital
markets and domestic borrowing to finance the growing public-sector
deficit became increasingly expensive (see table 15, Appendix).
Inevitably, money creation became one of the primary ways to finance
the deficit.
It is difficult for non-Brazilians to grasp the significance of
double-digit inflation for forty years, with triple- and even quadruple-digit
inflation in the 1980s. By the late 1980s, annual rates of inflation
were almost meaningless, and Brazilians themselves routinely characterized
inflation by its monthly rate, which in the early 1990s was over
35 percent. Between the end of World War II and Brazil's Real Plan
in 1994, the price level had increased more than 100 billion times.
Not only did inflation accelerate over the 1980s, but the rate
became more variable and less predictable. The frequency of price
adjustments increased, and wage and salary adjustments that had
once occurred annually were adjusted semiannually, then quarterly,
and in some markets monthly, as inflation accelerated. In other
markets, especially the capital markets, inflation had similar effects
in shortening contract periods. Few borrowers or lenders would dare
to make long-term commitments, and by the late 1980s most Brazilian
firms, as well as most wealthier individuals, held any excess assets
in short-term, highly liquid deposits that were literally known
as the "overnight."
The rise in indexation in Brazil after 1964 had permitted the government
to tap the supply of domestic saving by selling indexed government
bonds to savers, who were thus protected against the effects of
inflation on the value of such assets. Although indexed bonds were
regarded as a great success in the 1960s and 1970s, the need to
pay not only the interest but also the inflation adjustment became
an increasing burden for the government in the 1980s.
Despite the burden that indexed bonds placed on government finances
as inflation accelerated, inflation itself appears to have been
an important source of revenue for the government. The "inflation
tax," which is the real income that the government receives
through the issuance of new money, tends to increase with inflation,
because nonindexed money or partially indexed financial assets issued
by the government lose their real value. This loss in spending power
incurred by the holders of money is in effect a tax, because the
government spending financed by money creation is paid for by the
loss in value of the money held by the public. Attempts have been
made to measure the income that the Brazilian government earned
through the inflation tax, and some estimates suggest that income
from this source in the 1980s was over 3 or 4 percent of GDP.
Data as of April 1997
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