The Real Plan
From 1964 through 1994, the accumulated inflation rate in Brazil fetched 1,000,000,000,000,000 % (thatīs one quatrillion percent) !! This fantastic figure is not an estimative; it was calculated by Joelmir Beting, a well respected Brazilian journalist, based on the official inflation numbers.
The original report was published by Veja in Dec. 1996, but itīs available on-line for subscribers only; read a few comments about the matter written by Joelmir Beting
himself; if you want to calculate the inflation yourself, the official monthly inflation rates are available at
Fundacao Getulio Vargas - IGPs.
(Side question: why did the inflation last so long in Brazil? The answer is obviously very complex, but a few reasons are known.
First of all, the inflation was very convenient to the government; the Mint printed money around the clock, at a very low cost to the Treasury (the Treasury was collecting an inflationary tax); the Budget was fixed in nominal values, which were corroded very quickly, leaving the government with a carte blanche to spend the budget; by delaying payments (to suppliers, to servants, to people who won demands in Justice), the government was in fact getting discounts.
Second, there was in Brazil something called "monetary adjustments" (correįão monetária): any money left in the bank was automatically paid interest, overnight (Brazilian banks
had to gain much efficiency to operate with this high inflation); so, the middle class had their savings protected from inflation corrosion, and didnīt pressure the Government for a tougher combat against it; of course, as Beting notes on his article, someone had to support the burden, and those were the massive majority of Brazilians who didnīt have any savings left to invest into the bank system.
Last, there was the natural difficulty in understanding and combating inflation in a complex country like Brazil: many of the best economists in Brazil put their knowledge and good will to the service of the government, but, before 1994, they all failed).
Until 1986, inflation was fought (mostly) by following the Economics books. That year, yearly inflation was running at more than 100% for the second year in a row (1985: 225%), and the government felt the necessity to adopt more extreme measures against it.
In March of 1986, President Jose Sarney announced the Plano Cruzado, anchored in practically only one idea: all prices of the Economy were frozen (including salaries, but these had an increase first). The President assigned all citizens with the job to control prices in every shop in the country; TV showed supermarkets being closed and managers being arrested, because prices had been raised. The Plan worked fine for a few months (in November of 1986, the Party of the President won elections in all the Brazilian States), but natural sequels soon appeared: forbidden from changing prices, the producers either refused to sell (creating a black market for several products) or just relaunched "new" products with a "new" higher price. Late in 1986, right after the elections, the government came with Plano Cruzado II, with a general increse of prices and taxes.
From 1986 through 1994, a few other heterodox Plans were deployed. In 1987, the Bresser Plan (named after the Minister of Finances) again froze prices and salaries, besides cutting budgetary investments; outcome: accumulated inflation for 1987 was 366%. In 1989, the Summer Plan once again froze prices and proposed the privatization of State companies and the dismissal of civil servants; in December alone, the inflation was over 50%.
In 1990, the wildest plan of all, the Collor Plan. President Fernando Collor had taken office promising to kill the inflation with only one shot; accumulated inflation from March 89 to March 90 had been almost 5,000%. The main measure of the Collor Plan was to freeze all financial assets in bank accounts which exceeded a few thousand dollars (the money would be gradually returned to investors only after eighteen months); again, prices and salaries were frozen, budget expenses were cut, taxes were increased; the plan brought recession to Brazil, but didnīt stop inflation (December 90: 19.39%; 1990: 1198%). In 1991, the sequel: Plan Collor II; besides the usual prices freezing, this plan attacked the indexation: all short term financial transactions (which paid interest daily) were prohibited; the Plan Collor II failed, much because the President - who would be impeached in 1992 - had a weak political support.
The Real Plan
All the above mentioned plans, even if failing, contributed to show what would NOT work in combating inflation; the idea of a government acting volunteerly to prevent economic agents from increasing prices had been slowly ruled out (thatīs to say: Brazilians would not believe in any Plan which would impose price freezing); likewise, it was clear that the fiscal deficits were a major component of inflation, and despite all political difficulties envolved, the deficits would have to be addressed.
More and more it was clear that indexation was a major component of Brazilian inflation. Indexation means that every buyer or seller knew what the recent inflation rates had been, and would factor that index into their prices, contributing to increase the future inflation.
Obviously, the analysis of this phenomenon is not close to being so simple; Brazilian economists Persio Arida and Andre Lara Resende were the first to translate the idea into the written papers; the MIT economist Rudger Dornbush endorsed the ideas, and published them on one of his books about Macroeconomy.
In 1993, mr. Fernando Henrique Cardoso became Minister of Finances; mr. Cardoso called several of his academic friends to help him devise a new plan to defeat inflation; Lara and Arida were some of the main mentors of what would eventually become the Real Plan. Another proeminent character in the deployment of the Plan was mr. Gustavo Franco; while Lara and Arida never hode their discomfort with the political practices, Franco, who would become Director and President of the Central Bank, showed much more impetus to argue with politicians and implement his ideas.
In the words of Franco, the Real Plan was founded on three key elements: "i) a fiscal strategy centered on the approval of the Constitutional Amendment creating the Social Emergency Fund, while other reforms were enacted through a prolongued period of time; ii) a monetary reform process to take place during a few months of voluntary adoption of a new unit of account later to become the national currency; iii) a big bang approach towards opening the economy with aggressive trade liberalization and a new foreign exchange policy". These comments by Gustavo Franco (and respective explanations) can be read (in English, PDF format)
In brief, what the Real Plan proposed was:
i) Fiscal strategy. The Constitutional Amendment mentioned was the #17, approved on November 22nd 1997, which changed the articles 71 and 72 of the
Temporary Constitutional Provisions,
to extend the period of the Social Emergency Fund. Such fund was comprised of a few taxes (see art. 72) and, according to art. 71, should be used in some specific programmes, including those "of great economic and social interest"; in practice, what happened was that the government had more money in his hands and more freedom to spend it. The "other reforms enacted through a prolongued period of time" referred to the legal reforms approved and attempted during the two terms of President Cardoso; mr. Cardoso managed to privatize many State owned companies (including banks, steel plants,
one of the largest mining companies in the world,
all the telecommunication companies
and others - also worthy mention, the monopoly of Petrobras was broken) and also promoted significant changes in the civil service and in the social security of the private sector; other Reforms were attempted but failed: the reformm of the social security of the public sector, the labor legislation, the tax system, among others.
ii) Monetary reform. From the previous plans, a lesson was learned: freezing prices and salaries was innocuous against inflation; and the reason was, basically, that at any given moment, some economic agents had just realigned their prices, while others were just about to realign them; by freezing prices, an unbalance would be created between those with updated prices and those with outdated prices. The idea behind the Real Plan was to create an index, called URV (Unidade Real de Valor - Real Unity of Value), with daily variations, pegged to the dollar; prices would still raise in Cruzeiros Reais, but as the URV would also raise daily, the prices would be fairly constant in URVs (as much as they would in dollars); all economic agents would be encouraged to quote their prices both in Cruzeiros Reais (which would be effected by the high inflation rates) and in URVs (which, pegged to the dollar, would remain pretty stable). On July 1st 1994, the Cruzeiro Real ceased to exist; the URV became the Real; all prices would then be quoted in Reais; for contracts signed in Cruzeiros Reais, the conversion would be at the rate of 1 Real = 2,750 Cruzeiros Reais (yes, instead of just cutting zeros, as they were used to, all Brazilians had to deal with this complicated conversion). Because all economic agents had had enough time to realign their prices, there was not unbalances among them; by creating a super-index (the URV), the government managed to beat indexation.
iii) Opening the economy. In the first months of the plan, international scenario was in such situation that investors saw advantages in pouring massive amounts of capital in Brazil; in consequence, the real gained value against the dollar (US$ 100 = R$87), which helped importers and harmed exporters. Gustavo Franco was and still is a firm believer in free market and free trade, even at the cost of some companies failing and some people loosing jobs in Brazil (in the long term, the theory says, other companies would flourish and other people would find better jobs). So, for some time, Brazil lived with an overvalued currency which, despite of all collateral problems (including explosion of internal debt, closing of several industry sectors, etc), helped increase competition and keep inflation down.
Read how the Real behaved against the dollar, from 1994 to 2005.
The results of the Real Plan,
information provided by the Ministry of Finances
Personal site of ex-President of Central Bank, Gustavo Franco
Law nr. 9069, June 29th 1995. Full text, in Portuguese, of the law which instituted the Real Plan (the Plan was launched by force of a
Provisional Measure, in July 1st 1994).
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