360° Analysis

Price Inflation and Its Consequences in Brazil – Echoes of a Previous Era


July 20, 2011 18:12 EDT

Inflation is beginning to affect the Brazilian economy. Given the history of hyperinflation, Brazil places a high premium on economic stability. Voters and investors are, therefore, likely to push President Dilma Roussef into embarking on an austerity program.

A recent Nation Progress Report (NPR) on the origins and successes of Brazil’s 1990s Real Plan offered a grim reminder of the damage food price inflation did to Brazil. In order to keep pace with rampant hyperinflation shop owners would reset prices on items while consumers were still perusing the aisles for groceries.  Though not nearly as malignant as the price inflation that infected Brazil in the past, inflation of food and commodity prices in the Latin American state have increased as part of a general global trend.  In a state that has enjoyed remarkable economic prosperity since the 2002 Latin American commodity boom, Brazil is experiencing inflation levels unseen since the first term of previous president Luiz Inacio Lula da Silva. Yet the observers expect that inflation will remain confined to the single digits, a far cry from the estimated over 1,000% hyperinflation Brazil once saw. Nonetheless, Brazil’s inflationary levels remain worrisome to its policy makers and the population for a number of reasons. For one, the nation is extremely sensitive to any kind of inflationary pressure given the nightmare of the yesteryear which completely devaluated the predecessors to the Brazilian currency, the Real (BRL).

A legitimate concern is that if the current pattern of price inflation remains, it could prompt a devaluation of the currency, hindering the state-level currency stability that Brazilian leaders have worked so hard to maintain since overhauling the Real in 1994. Whether such devaluation will occur remains to be seen but Brazilians do expect the current pattern of inflation to continue.  A second lingering concern about food price inflation is its exacerbating effects on existing wealth and income disparities in Brazil.  With a Gini coefficient hovering just over .50 (the Gini Coefficient is a measure of income inequality; a measure of 0 indicates complete equality and equal incomes for all. The closer the measure is to 1.0, the higher the inequality), Brazilian leaders, particularly the leftist ruling PT, have made a concerted effort to reduce such disparities. Food price inflation hits lower income families particularly sharply, given the high percentage of their income they spend on food products. As such, the current inflationary trend will worsen the fortunes of lower class Brazilians just when it seemed that economic growth and government expenditure on social welfare would improve their status. To combat inflation, Brazilian leaders have begun to enact a series of interest rate hikes and fiscal austerity measures.

Such measures are akin to those already enacted by Brazilian leaders like Fernando Henrique Cardoso and Lula who resuscitated and strengthened Brazil’s economy via such an orthodox economic program. While such policies have worked in the past, they have distinct political and economic drawbacks. The reigning political party, the PT, upon its ascent to the executive, was initially unable to undertake the kind of social spending that a leftist party would have normally been expected to undertake. As economic stability had become a prime concern to Brazilian voters and since foreign investors had become uneasy of what reforms the party might undertake, the PT had to adopt a markedly non-leftist economic policy and control government spending. In the last few years though, the PT government has been able to expand government spending while backing off more orthodox economic policies. Brazil’s previously high interests rates were reduced, (though still remaining the highest in the world,) while the government raised the minimum wage and expanded social welfare programs like the widely copied Bolsa Familia program. These actions further facilitated Brazilian economic growth and Lula’s successor, Dilma Roussef, promised to continue Lula’s policies while running for the presidency.

However, if Brazil is to escape inflationary pressures, it will have to scale back its social spending and improve conditions for domestic investment. Politically, such a shift is disadvantageous to the PT which will have to once again forego the more heterodox economic policy it has preferred over the last few years. Electorally, the implications of such a shift are not so easy to ascertain.  On one hand, the PT’s cut in spending will hurt its support among constituents who benefit from its expanded pension and welfare programs. However, the importance of preserving economic stability has also been paramount to voters given the not so distant memory of the early 90s. In fact, parties running against orthodox economic policies designed to combat inflation have historically fared poorly in elections. The previously anti-orthodox policy of the PT, partly accounted for its defeat in the 1998 elections. Economically, the return to orthodox economic policy has its own negative implications. Economic growth in Brazil will likely be reduced by new anti-inflationary measures. Higher interest rates, raised again by the government, along with new constraints on domestic lending will reduce domestic investment. Meanwhile, a continued effort by the Brazilian government to maintain the strength of the real may result in the currency becoming overvalued. Given these sacrifices and consequences of controlling the current wave of inflation, the Brazilian government faces tough economic choices.

President Rousseff has been criticized as wavering on economic policy. She is said to have avoided stringent measures to curb spending and, therefore, failed to preserve the strength of the real. Nevertheless, her administration has already taken requisite steps. Counter-inflationary measures generally put a strain on governments, deteriorating their electoral support. Brazil is in a different situation because of its experience with hyperinflation. A government that institutes counter-inflationary measures is likely to retain support as Brazilians value price stability. So Rousseff and her current PT government do not need to worry about electoral consequences when they follow an anti-inflationary policy. Rousseff’s recent claims that inflation is on the downturn are dubious and it would be foolish for her government to eschew austerity given the inflation concerns of her own voters and foreign investors.  Therefore, we can expect Rousseff’s government to embark on an austerity program once inflation starts causing alarm.


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