The inflationary process in Brazil and its relations with the public sector deficit and debt

This paper offers an interpretation of the Brazilian inflation and comments brieflyon the Cruzado Plan. It emphasizes two points. First, there are the problems of fiscal consolidationin the presence of a large public debt. What is missed in many analyses of stabilizationprograms is precisely the particular debt situation, and the role of foreign exchangeavailability in successful versus non-successful programs. Secondly, we discuss the role ofbudget deficits in the inflationary process in Brazil. Seignorage models as an explanation for inflation in Brazil are dismissed on the grounds that seignorage as a share of GDP shows absolutelyno correlation with inflation. The money-goods model of monetarism is inappropriatefor the Brazilian economy because it predicts that seignorage drives the system. But theBrazilian experience on the contrary has to be interpreted in the light of changing sourcesof financing the budget. The inflation acceleration between 1979 and 1985 is linked to theswitch from external to domestic finance, and the large trade surpluses that pushed up interestrates and inflation. The paper develops a model that shows a pattern of adjustment forincreasing inflation induced by increasing equilibrium real interest rates, that matches theBrazilian data. The Cruzado Plan failed to pay attention to the debt problem and the needfor budget consolidation (probably through debt relief and a capital levy). In the absence ofan integrated approach, it pushed the economy into a classic inflationary finance situation. JEL Classification: E31; E52.