Can Brazil lose control of inflation? A brief history of inflation before the Real Plan

RIO DE JANEIRO, BRAZIL – Former president of the Central Bank and adviser to the Brazilian Center for International Relations (CEBRI) think tank Armínio Fraga said in a VEJA cover story that he fears much of the control efforts made during the creation of the Real Plan and in the following years could be lost.

“That would be worse than frustrating. It would be a great shame,” he said. “We are running this risk, there is no doubt about it, and it would be very serious. There is no way to describe it any other way. What would happen if we started to reindex the economy? It would be terrible.”

According to the economist, the best way to face this risk would be for society to decide what role and size of state it wants for Brazil, so that the hole in public accounts is reduced and spending is directed to what is considered a priority.

“A technocratic answer for facing the current inflation would be to make reforms, to rethink the priorities of public spending in Brazil and stop this growth in spending. Behind this proposal are political decisions of great importance that are clearly not being discussed at the moment, and an adequate reform of the state,” he says.

“It would be necessary to complement the social security reform, which left loopholes, eliminate subsidies, and try to avoid regressive tax expenditures that make no sense. There is room to work on this issue, but this has not been the case. It is a question that goes beyond the pandemic. It concerns the solidity of Brazilian institutions, something that is being tested.”

Currently, inflationary expectations are proving difficult to tame. For 26 consecutive weeks, the projection of the IPCA for 2021, as measured by the Central Bank’s Focus Report, has increased. But even if the institutional tension between the branches of government and the fiscal issues worry those who wish to invest in the country, jeopardizing the control of inflation, still few believe that Brazil will ever again face hyperinflation, as experienced in the 1980s and early 1990s.

“We are very far from that today. At that time, Brazil decided to coexist with inflation. Not today, no one wants to live with inflation. Everyone is discussing alternatives as to what the best way to fight it would be. This is the main difference,” argues economist Edmar Bacha, who was one of the creators of the Real Plan and who is preparing a book entitled “No país dos contrastes – da inflação ao Plano Real” (In the land of contrasts – from inflation to the Real Plan).

According to Bacha, after the military coup, Planning Minister Roberto Campos and Finance Minister Otávio Bulhões chose a policy of stagflation, to lower inflation, which at the time of João Goulart’s government stood at around 90%. They managed to stabilize it at 20%. But from that point on, with the departure of the two and the arrival of Delfim Netto, who took over the Treasury in 1967, the military government chose to roll up its sleeves.

“And then they improved the whole system of price indexation to be able to coexist with inflation, so that inflation wouldn’t have such a negative effect,” Bacha says. “But then what happened is that by living with inflation of 20%, it quickly increased to 40%, to 80%, to 200%.”

And that’s how a historically high inflation became hyperinflation. “Brazil has experienced persistent inflation for a long time. We had some surges like in World War II and in the Dutra government with orthodox policy and with a number of historical issues like the Korean War. But the beginning of this acute inflation process began in the 1950s,” explains one of Brazil’s leading inflation specialists and a professor at FEA-USP Heron do Carmo.

“With the military intervention, for the government to be viable, it was much more important to maintain growth than to fight inflation. In the beginning, with the introduction of monetary correction, there was a friendly coexistence with inflation, because it was reduced until 1973. But, after the oil shock of that year, things changed completely.”

Then, in the 1980s, “increasingly exotic” price control alternatives were attempted, culminating with the Collor Plan’s confiscation of savings. Only the Real Plan worked, by introducing a “different paradigm, of making adjustments beforehand and explaining through the press what was being done, convincing economic agents that there was no reason to cause losses.”

But those who think that the Real Plan worked magically, without much effort on the part of all involved, are mistaken. The project was led by Minister of Economy between 1993 and 1994, Fernando Henrique Cardoso (FHC), and includes names like Bacha, Pedro Malan, Pérsio Arida, André Lara Resende, Gustavo Franco and Gustavo Loyola in its ranks.

Jurist, historian and diplomat Rubens Ricupero succeeded FHC as Economy Minister, when he ran for the presidency of the Republic, and put the plan into action during his tenure at the Ministry of Finance, between March and September 1994. He says that on the eve of the launching of the Real, President Itamar Franco still had doubts about whether it would not be better to retreat and bet on a more conservative and simple proposal, similar to the previous ones, through price control. On June 30 1994, Ricupero was in charge of taking the provisional measure consolidating the plan to Itamar.

On that day the president sent the then Minister of Justice Alexandre Dupeyrat Martins to the Ministry of Finance. He was received by Ricupero and Pérsio Arida. “Dupeyrat began to adopt the attitude of a severe school inspector, contesting points of the proposal, to the point of impertinence,” Ricupero recalls. The then-Minister got up in anger and called the Planalto Palace. In a conversation with Ruth Hargreaves, then the president’s personal secretary, he demanded to speak to Itamar. “If the president doesn’t call me in the next few hours to talk, something very serious is going to happen,” he declared.

“I will ask the president who the Minister of Finance is,” Ricupero snapped back at Dupeyrat. “I don’t need the position and I’m leaving,” he repeated. In his conversation with Itamar, the president confirmed to Ricupero his role as Minister of Finance, reiterating his confidence in the Real Plan. The following day, the project was put into practice.

The work involved conversations with the sectors, to understand their pricing policies. The main person responsible for this task was Milton Dallari, who had been in charge of the special secretariat for price supply during Delfim Netto’s Ministry. During the first months, there were more than 2,000 meetings with the various segments of the Brazilian economy. “We discussed in detail the economy’s price-directors, which were nothing more than the exchange rate, interest rates and inflation, which governs the country’s entire economy.”

“We traveled virtually all over Brazil holding meetings whose basic goal was to implement the URV (an intermediary currency created before the real came into circulation) without controlling prices,” Dallari says. “We would come to a meeting with the pharmaceutical industry, for instance, and say: ‘We need to convert the current prices of the industry into URV. The drug Novalgina, how much does it cost? It cost 1 cruzeiro novo, for instance. ‘Look, it will now cost one URV.’ Many could not understand, until we started explaining, explaining, educationally, so that all entrepreneurs understood that it was a release of prices, albeit with monitoring.”

It was thanks to stories like these that Brazil left behind supermarket lines to buy products before they became more expensive, a necessity for virtually every family in the country. From December 1989 through March 1990, prices doubled every 35.1 days. Compared to the biggest hyperinflations in history, Brazil and other Latin American countries’ hyperinflations may seem mild.

According to a study conducted by professor of applied economics at Johns Hopkins University in Baltimore and one of the world’s leading experts on the subject Steve H. Hanke, there have been 62 hyperinflation events in the world – in which the monthly rate exceeded 50%.

The worst were in post-war Hungary, when prices doubled every 15 hours, and in Zimbabwe from 2007 through 2008, when this happened every 24.7 hours. The most classic, however, was Germany in the interwar period. When the country failed to pay the bills foreseen by the Treaty of Versailles in 1922, the French invaded the Ruhr Valley, the country’s industrial heartland, and halted production.

The result was that the German mark, which was worth 25 cents on the dollar in 1914, was quoted at 4.2 trillion on the dollar in 1923. In a single day, the price of bread skyrocketed from 20,000 to 5 million marks. Such economic turmoil spurred Adolf Hitler to attempt, that same year, the Beer Hall Putzch, which, although unsuccessful, gave him the credentials to take over the country for the Nazis a decade later, this time legally.

“Most emerging market countries have Central Banks with great discretionary power and very little credibility. They rarely meet their inflation targets and often produce junk currencies. In this sense, Brazil is no exception,” Hanke harshly says, who served on President Ronald Reagan’s council of economic advisors between 1981 and 1982 to deal with the inflation of the time, and who was also called upon to fight monetary crises in Argentina (1991), Estonia (1992), Lithuania (1994), Bulgaria (1997), Bosnia-Herzegovina (1997) and Ecuador (2000).

Thanks to the Real Plan, Brazil has not found itself in such dire straits in recent decades as those countries and Venezuela today. But even if a new hyperinflation seems distant, the current government needs to be responsible to prevent the country from regressing. After all, as the fiscal issue shows little control, particularly at a time when the federal government intends to spend more to seek reelection, the only measure to fight inflation has been the Central Bank’s interest rate policy. This may be insufficient.

Source: Veja