Brazil Inflation and Indexation Cycle

By Amy Skalmusky, Senior Contributing Reporter

RIO DE JANEIRO, BRAZIL – In the late 1980s and early 1990s inflation in Brazil reached out-of-control levels and many people lost their savings, homes and jobs. One of the economic measures introduced to combat hyper inflation, price indexing, is still around today and many experts believe it a dangerous relic that should be scrapped.

In the past, with inflation reaching around 2,000 to 3,000 percent a year during the Eighties and Nineties crisis, the price indexing was an attempt to maintain people’s buying power.

Not only salaries, but the prices of various goods and services, such as electricity, rent and telephone were tied to different indexes and adjusted frequently. Unfortunately, prices rarely went down.

Though Brazil has enjoyed a relatively stable economy for over fifteen years, indexed price adjustments continue to be a fact of life. The prices of essential services such as electricity, rent and phone go up yearly based on a given index.

For example, electricity and phone are indexed to the IGPM (or the General Index of Market Prices). This index went up 10.56 percent from January to October of 2010, according to the Institute of Economic Research. This value will be the base for 2011 price increases.

The minimum wage is also adjusted yearly. The amount of increase is determined by adding the inflation from last year (IPCA) to the change in the Gross Domestic Product from the previous two years.

That value, 6.86 percent this year (to R$540/month), influences not only the approximately 13 percent of the population that receive minimum wage , but the entire working population. The minimum wage increase serves as a base for labor unions to enter into yearly collective bargaining agreements with employers.

Unlike American union membership, which is under 9 percent, Brazilian worker labor union membership is required by law. Bargaining outcomes are automatically extended to all workers in the industry. For employers, this means giving employees a “dissidio”, or mandatory raise every year.

Mandatory, yearly price hikes and pay raises increase the costs of goods and services, which in turn feed into the indices that measure inflation, such as the IPCA and IGPM. These indices are then used as the basis for price increases for the same goods and services.

According to Miriam Leitão, noted economic reporter, indexing is like a dog chasing its own tail: “Inflation increases when prices go up. Prices go up because of increased inflation,” she said in an interview with CBN radio.

Though price indexing may have worked in the past to protect people from hyper inflation, nowadays, it hides any drop in inflation and contributes to pushing prices higher.