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Monetary Policy in Brazil

Seminararbeit 2011 14 Seiten

Leseprobe

Table of Contents

Executive Summary

List of Abbreviations

List of Figures

List of Tables

1. Introduction

2. Brazils Monetary Stabilization Efforts in the 1990s

3. Analysis of Relation between Money Supply and Inflation

4. Dichotomy of Economy

5. ITM Checklist

Bibliography

Executive Summary

Brazil is the largest country in South America with the highest population. Since 2003, Brazil has improved its macroeconomic stability and built-up foreign reserves. They have further reduced debt and managed to keep inflation rates under control while committing to fiscal responsibilities. Nevertheless, back in history, from the 1960s to 1990s the country was struggling with continuously high inflation rates until Fernando Henrique Cardoso, the minister of finance and later president of Brazil, introduced the “Plano Real” 1st of March 1994.

The assignment describes the financial history of Brazil between the 1960s and 2000 in brief by giving some numbers about inflation rates and highlighting potential reasons for the long period and high rates. The work describes further on the stabilization efforts in the 1990s in Brazil by introducing the “Plano Real”, explaining the idea of introducing the Unidade Real de Valor, a parallel, virtual and relative currency to the Cruzeiro Real. In the third chapter the economical relation between money supply and inflation is explained by the quantity theory of money and an alternative to express inflation, the quantity equation, is given. The last part of the essay explains the classical dichotomy in economics in general and analyses the economical data of Brazil for the 1990s in this regards. The assignment is concluded by the ITM checklist.

List of Abbreviations

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List of Figures

Figure 1: Brazil's Inflation Rate 1970 to 1989 (Roberto F. Iunes, 1993, p.38)

Figure 2: Quantity theory of Money (Mankiw, 2001, p.639)

Figure 3: Brazil Economy Data 1991 – 2000.

List of Tables

Equation 1: Quantity Equation

1. Introduction

An accumulated inflation rate of 1,000,000,000,000,000% (one quadrillion percent) between 1994 and 1994 was calculated for Brazil by Joelmir Beting in 1996[1].

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Figure 1: Brazil's Inflation Rate 1970 to 1989 (Roberto F. Iunes, 1993, p.38)

The reason for the high inflation and the long period had several reasons but three of them are obvious. Firstly, the inflation was somehow convenient for the government because the money was printed for a relative low cost for the Ministry of Finance due to collection of inflationary taxes. Secondly, the monetary adjustment, money left in the bank was automatically paid interest overnight, protected the savings from inflation and therefore the government did not face too much pressure from the mid- and upper-class to react against.

Thirdly, understanding inflation in a complex country like Brazil and further more finding appropriate counteractive measures is a highly sophisticated task were many of the best economist of Brazil were involved without success until 1994. In 1994, after several initiatives, the financial minister of Brazil introduced the “Plano Real”. The plan brought economical stability to Brazil and enabled to keep up economic growth through the last decade.

2. Brazils Monetary Stabilization Efforts in the 1990s

In the 1990s Fernando Henrique Cardoso, the minister of finance and later president of Brazil, introduced the “Plano Real” 1st of March 1994 with the objective to stabilize the economy. The basic idea of “Plano Real” was to incorporate into international economy by stabilizing the currency and initiating structural reforms in parallel (Parkin 2010).

In General, keeping relative prices with respect to scare resources, are typically leading to an increase in productive investments consequently building the fundamental for an economical recovery. Further on, opening the domestic market for international capital usually brings international technologies as well which are speeding up the process in addition (Bain 2003).

The “Plano Real” was quite successful in stabilizing the currency, neither prices nor savings were frozen but the inflation index was used to create a new non-monetary reference currency, referring to as “Unidade Real de Valor” (URV), within a well prepared change process. The idea behind the new parallel currency to the “Cruzeiro Real” (CR) was to be independent from the inflation by aligning prices to the USD. All goods were priced in both currencies but still had to be paid in CRs. The URV prices were constant over time whereas the others changed on a daily bases (Plano Real 10.01.2011).

The goal of establishing a fictive currency was to unbias people from their expectation in daily raising prices by giving them fixed ones as a reference which leaded after some time also to stable CR prices. After achieving stable prices the virtual URV was used as basis for a new real currency, referring to as “Real”. The “Plano Real” stabilized Brazil’s economy in the 1990s and enabled a continuous economical growth.

3. Analysis of Relation between Money Supply and Inflation

A continuous price raise of goods and services is commonly known as inflation which means the buying power of a currency decreases. In general, there’s a direct relation between the inflation rate of an economy and the amount of money supplied. The mechanism by which excess money is translated into inflation is as follows. The aggregated demand is raised by spending excess money for goods and services which directly impacts into inflation. Further on, a demand raise of labor directly contributes into a higher demand for goods and services which will again raise salaries and labor costs. The more inelastic an aggregated supply is, the higher the impact in inflation is. On the other hand, an increase in demand of goods and services will lead potentially to higher import rates which has a negative impact in the domestic economy and for this reason reduces the money supply. Even more, increased import rates will raise the money supply of foreign exchange markets and therefore lower the exchange rates and increase the inflation rate again.

In order to explain the relationship between money supply and inflation the quantity theory of money can be used as a first approximation. The theory was developed by economists at the beginning of the twentieth century. In general, the assumption describes how the nominal value of aggregate income is determined as well as the demand for money. The theory provides data in addition about how much money is held for a given amount of aggregated income.

illustration not visible in this excerpt

Figure 2: Quantity theory of Money (Mankiw, 2001, p.639)

A typical behavior of an increase in money supply as shown in Figure 2, decreases consequently the value of money and as a result raises the price level of goods and services, commonly known as inflation. In other words, as shown in Figure 2, the point of equilibrium changes from ‘A’ to ‘B’ which means and increased money supply reduces the buying power of the currency.

With the theory of money the link between money supply and inflation can be described as follows. A salary increase of 10%, equal a 100 per month, is increasing the buying power at a first glance which means a 10% price increase from 10 to 11 for a certain good or service is probably acceptable but devaluates the buying power. With respect to Figure 2 the money supply goes from MS1 to MS2 and consequently the price level P for goods and services increases respectively the value of money 1/P decreases.

As an alternative for the quantity theory of money the quantity equation (Equation 1) can be used. The equation describes the effect the quantity of money has in an economy.

[...]


[1] The report was published at VEJA.com for online subscribers only

Details

Seiten
14
Jahr
2011
ISBN (eBook)
9783656495420
ISBN (Buch)
9783656495581
DOI
10.3239/9783656495420
Dateigröße
892 KB
Sprache
Englisch
Institution / Hochschule
FOM Hochschule für Oekonomie & Management gemeinnützige GmbH, München früher Fachhochschule
Erscheinungsdatum
2013 (September)
Note
1.7
Schlagworte
Economics Brazil Plano Real Unidade Real Monetary CR GDP URV USD

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Titel: Monetary Policy in Brazil