Fiscal imbalance, indexation and regime changes and inflation expectations: the dynamics of inflation rate in Brazil from 1960 to 2005.

Abstract

This paper analyses the Brazilian inflation dynamics from 1960 through 2005. We followed the Cagan’s hyperinflation model and employed a descriptive methodology. Based on the data collected, the roots of the inflation’s behavior, as well as the regime changes, are identified; consequently an inflation periodization is carried out. Like wise, speculation about the inflation expectations formation rules was presented, followed by economic agents in each inflation phase. The central argument lies on the fact that throughout the 1960-1994 period, the Brazilian economy faces a permanent fiscal imbalance partly financed by money issuing. Similarly, as of 1964 a simultaneous price and contract indexation system is implemented. Together with the public deficit, it forms a propitious environment for an inflationary process that accelerates at each internal or external supply shock, as well as each demand shock from the private sector. As an outcome, the early 80s’ so-called “low” inflation is replaced by megainflation, which endures until 1994.06 as of the implementation of Plano Real. Although the imbalance of public accounts is not solved, a significant fraction of the indexation system vanishes, and inflation resumes its previous one-digit-a-year mark. The credibility of the demand controls as tools to stabilize inflation is recovered. To such controls an intermittent exchange appreciation policy is added. Economy then faces a stop-and-go regime. As a result, the GDP growth rate is considerably poor.

Key words; Fiscal imbalance, monetary supply, Central Bank policies, inflation rate, indexation system regime changes