BRAZIL FIGHTS A REAL BATTLE
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SUGGESTED ANSWERS TO BRAZIL FIGHTS A REAL BATTLE
1. How does Brazil hope to control its trade deficit through a tight monetary policy? What alternatives are
available to control the trade deficit?
ANSWER. A tight monetary policy will raise real interest rates and slow down growth, which should act to curb
2. How will Brazil’s tight money policy affect its fiscal deficit? How will it affect Brazil’s real (inflation-adjusted)
interest rates, both short-term and long-term rates?
ANSWER. By raising interest rates, it raises the cost of rolling over government debt and therefore boosts the deficit.
A tight monetary policy will also boost real short-term rates. However, if the policy is credible–that is, if people
3. Why have Brazil’s interest rates generally fallen in recent years?
4. How would reform and privatization of the social security system improve Brazil’s savings rate? What would be
the likely consequences of this improvement for Brazil’s current-account balance and the real’s value? Explain.
ANSWER. One of Brazil’s fundamental problems is its bloated pension system, especially for government
employees. Under this program, many civil servants are able to retire at age 45 with a fat pension, then take a second
5. What are the costs and benefits of using currency controls to defend the real?
6. Why might speculators view the real as being overvalued? Based on the data in the case, what is your best
estimate as to the real’s degree of overvaluation?
ANSWER. We can see what has happened to the real value of the real by using the economic data in Exhibit I 4.2.
7. What are the tradeoffs that President Cardoso must consider in deciding whether to accelerate the real’s
depreciation?
ANSWER. President Cardoso’s popularity has been built on economic stability. Devaluing the real would jeopardize
that stability and his popularity. On the other hand, the sky-high interest rates designed to pull in the foreign
8. Could Brazil have avoided the recessionary impacts of its monetary policy if it had devalued the real instead?
ANSWER. No. It would have wound up with high inflation and high interest rates, as evidenced by the Asian
countries that devalued as well as by Mexico. In fact, on January 13, 1999, Brazil devalued the real after facing
9. What would a Brazilian devaluation do to the currencies and economies of Argentina and Chile, its neighbors
and largest trading partners?
BRAZIL FIGHTS A REAL BATTLE
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ANSWER. The impact on the Argentine and Chilean pesos will differ because of their different currency setups.
10. What is the link between Brazil’s budget deficits and its hyperinflationary environment?
11. What mix of fiscal and monetary policy would you recommend to President Cardoso? Should he devalue or
defend the real?
ANSWER. The real issue is not defense of the real but rather whether Brazil will make serious structural changes in
its economy, particularly a major reduction in the size and cost of its public sector. Failure to make these changes
will guarantee that Brazil will be forced to devalue the real in the future, whatever its current success in defending