Government Maintenance of the Exchange Rate: The Case of the Brazilian Real Plan (1994-1999)
Since Brazil was experiencing hyperinflation in the early 1990s the country construed the Real Plan of 1994-1999, which stopped hyperinflation with an exchange rate based stabilization program. However, keeping the fixed exchange rate was not easy. The central bank and the federal government are both heavily involved in managing the exchange rate. Even though domestic inflation was curbed, the authorities had problems maintaining the exchange rate peg. The following discussion and purposes of this paper are threefold: (a) it addresses why the Assignment Rule did not work for Brazil; (b) because the general consensus among economist of why Brazil had a devaluation is its high fiscal debt, this paper will investigate if any way existed for Brazil to avoid a devaluation without severe macroeconomic consequences-either by making a fiscal adjustment or by financing the current account deficit-and; (c) it addresses why government should be cautious when estimating the extent to which they can handle a fixed exchange rate. The high budget deficit was at the root of this problem; however, the authorities seemingly could not conceive that the domestic economy could handle the contractionary results of a fiscal adjustment. Evidence implies that a fiscal adjustment with a loose monetary policy would not only have been good for the internal sector but also helpful for lowering the current account deficit. Thus, the paper hypothesizes that the Assignment Rule would not have worked for Brazil during the Real Plan and argues that government authorities should be cautious when relying on the international economy to fix a domestic problem.
School:
University of Texas at San Antonio
Department:
Economics
Research Advisor:
Hadi Eshfahani
Department of Research Advisor:
Economics
Year of Publication:
2003