Plano Real
The Latin American Economy
Based partially on
“Avoiding some costs of inflation and crawling toward
hyperinflation: The case of the Brazilian domestic
currency substitute by Márcio Garcia.”
Classical Hyperinflation
“The pattern of a classical hyperinflation is an acute
acceleration of the inflation level accompanied by rapid
substitution away from domestic currency.”
– Márcio Garcia.
*
Classical hyperinflation = acute acceleration
of inflation rates until reaching extremely
high levels followed by rapid substitution
away from domestic currency (e.g.
dollarization).
Monthly Inflation Brazil
• This shows that despite high levels of
inflation (even Hyperinflation as defined
by certain authors) before plano Real,
Brazilian inflation was not killed and did
not show classical (explosive)
hyperinflation.
• Next table also shows that Brazil
exhibited surprised economic resilience
to high levels of inflations
Brazil: Real GDP growth and
Inflation
• Why Brazil did not face hyperinflation?
• Was there something different from
other economies facing similar
problems?
• Yes.
Two key elements played a role
differentiating Brazil from the classical
hyperinflation 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 inability
to fight inflation and the unwillingness of
Brazilians to face the costs of such a
fight.
The provision of domestic currency
substitute helps explain (on political
aspects) why fighting inflation was not a
priority. Those with access also had
more political access.
Main reasons to Brazilian
Hyperinflation
1. 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
Strategies to Fight Inflation
1. Wage and prices freezes
(Cruzado Plan)
2. Set exchange rate, public sector
prices and oligopolistic sector prices to
a slowly decline path (Delfim Plan)
– Both heterodox plans
3. Monetary Reform (budget balance,
etc)
Real Plan
•
Real Plan started at 1993 and it was divided
in three stages:
1. Budget balancing – 3 months of negotiation
2. Introduction of URV - 4 months
3. New currency implementation - Real
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
URV
• URV - unit of real value (or Unidade
Real de Valor)
• Domestic unit of account with a virtual
exchange rate
1 URV ~ 1 dollar
• The URV would be adjusted daily by the
Central Bank to keep its real value
(adjust to compensate inflation)
URV
• All prices and contracts were slowly
converted to multiples of URVs
• Once all contracts were converted to
URV the government would start issuing
a new currency: the real
• The goal of the URV was to index
completely the Brazilian economy to the
URV: keep relative prices stable
– Worked as a Nominal anchor.
Why not simple adopt a
nominal anchor right way?
• Brazilian economy was highly indexed,
however different contracts had different
periodic adjustment clauses
– It would create dispersion of relative real
prices with some prices that were recently
adjusted higher than others
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 and
others at the bottom --> generating
inflation pressure
• This is an important component of the
inertia behind Brazilian inflation
– URV allowed prices to be fully aligned
(during 4 months), avoiding the problems
of sudden stop
1 Real = 2750 Cruzeiros Reais
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 the
exchange 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 at
URV became fixed in nominal terms real
Plano Cruzado
• Drastic measures
against inflation
• New currency
• Annual adjust of
rents and mortgages
• Prices will be frozen
News at the
time:
• “Start the war
Real X Inflation”
• It was word cup time
(We won ),
Maradonna was
caught on drugs
Why the plano real was
successful while others failed?
Why the plano real was
successful while others failed?
• We won the 1994 World Cup!
– Not really.
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.
Why the plano real was
successful while others failed?
• Series of reforms:
– Contractionary fiscal and monetary
policies, increased interest rates
(increasing foreign reserves)
– Strong focus on balance of payments
Annually Inflation and Money Supply Growth