A strong example of the fiscal theory of the price level. Also, an interesting example of why the Taylor Rule in the usual form (\phi_\pi > 1) is unnecessary under commitment (Ricardian).
"I run in to a lot of doubt about rational expectations, and ordinary people understanding events. Brazilians seem perfectly capable of it." Powerful statement. I'd move a copy to the beginning.
It never ceases to amaze me how easily "The Knowing" dismiss the ability of "The Ordinary" to understand events and make MB/MC decisions.
Yes, H.L.Mencken's worst blunder was when he said, "Democracy is a pathetic belief in the collective wisdom of individual ignorance." Somehow the collectively ignorant consistently outsmart our *GLORIOUS LEADERS*
In the late 1990s, Brazil abandoned the 1:1 exchange rate with the dollar, first with exchange-rate bands and later by adopting a floating exchange rate. The real depreciated, and this movement intensified when it became clear that Lula would win in 2002. After that, he released the “Letter to the Brazilian People,” which helped adjust expectations. He also appointed Henrique Meirelles to head the Central Bank, who followed the neoliberal playbook.
This, combined with a reform of public-sector pensions and the China effect, created a more favorable environment for expanding government spending and the minimum wage without major inflationary pressures. The exchange rate (BRL/USD) fell from 3.80 in October 2002 to 2.86 a year later.
During Dilma’s administration, the “New Economic Matrix” was implemented, which basically combined a forced reduction in interest rates, credit expansion via public banks, tax breaks, and price controls on administered prices (mainly energy and fuels — Petrobras is state-owned). After these prices were freed, inflation exploded.
After the impeachment, her vice president, Temer, took office. Henrique Meirelles — yes, the former Central Bank governor under Lula I — became his finance minister. In addition to abandoning the New Economic Matrix and approving some reforms such as the labor reform, I would say the main factor anchoring expectations was the spending cap, a constitutional amendment that prohibited federal spending from growing above the previous year’s inflation — meaning, in theory, no real increase — and would remain in force for 10 years. It wasn’t fully respected throughout the entire period, but it served as an important brake given Brazil’s fiscal history.
In 2023, Lula III abandoned the spending cap and introduced a new fiscal rule, essentially a looser cap allowing real spending increases depending on revenue growth. The government has not met its nominal deficit targets, and year after year, certain expenditures have been excluded from the calculation to allow compliance with the rule. If targets were not met, some automatic triggers would be activated.
The funniest part is that everything looks fine and perfect. Unemployment is at a historic low, the exchange rate has appreciated, and inflation is falling (though still above the target ceiling since he took office in 2023). And the market doesn’t seem rattled. Brazil is a ticking time bomb that never explodes.
I'm Brazilian. A similar process occurred around the last election (2021): Bolsonaro implemented a fiscal expansion, and after Lula was elected, they revised Temer’s fiscal rule to increase the federal government's fiscal capacity. We saw inflation above target in each of the last three years, and in 2025, it's projected to be right at the top of the target range.
When a country has 6 stabilization plans less than 40 years, you have don’t have a plan; you a fiscal mess
A strong example of the fiscal theory of the price level. Also, an interesting example of why the Taylor Rule in the usual form (\phi_\pi > 1) is unnecessary under commitment (Ricardian).
"I run in to a lot of doubt about rational expectations, and ordinary people understanding events. Brazilians seem perfectly capable of it." Powerful statement. I'd move a copy to the beginning.
It never ceases to amaze me how easily "The Knowing" dismiss the ability of "The Ordinary" to understand events and make MB/MC decisions.
Yes, H.L.Mencken's worst blunder was when he said, "Democracy is a pathetic belief in the collective wisdom of individual ignorance." Somehow the collectively ignorant consistently outsmart our *GLORIOUS LEADERS*
The role of credibility and commitment is key, the bcb was far from independent at the time
Some pieces missing:
In the late 1990s, Brazil abandoned the 1:1 exchange rate with the dollar, first with exchange-rate bands and later by adopting a floating exchange rate. The real depreciated, and this movement intensified when it became clear that Lula would win in 2002. After that, he released the “Letter to the Brazilian People,” which helped adjust expectations. He also appointed Henrique Meirelles to head the Central Bank, who followed the neoliberal playbook.
This, combined with a reform of public-sector pensions and the China effect, created a more favorable environment for expanding government spending and the minimum wage without major inflationary pressures. The exchange rate (BRL/USD) fell from 3.80 in October 2002 to 2.86 a year later.
During Dilma’s administration, the “New Economic Matrix” was implemented, which basically combined a forced reduction in interest rates, credit expansion via public banks, tax breaks, and price controls on administered prices (mainly energy and fuels — Petrobras is state-owned). After these prices were freed, inflation exploded.
After the impeachment, her vice president, Temer, took office. Henrique Meirelles — yes, the former Central Bank governor under Lula I — became his finance minister. In addition to abandoning the New Economic Matrix and approving some reforms such as the labor reform, I would say the main factor anchoring expectations was the spending cap, a constitutional amendment that prohibited federal spending from growing above the previous year’s inflation — meaning, in theory, no real increase — and would remain in force for 10 years. It wasn’t fully respected throughout the entire period, but it served as an important brake given Brazil’s fiscal history.
In 2023, Lula III abandoned the spending cap and introduced a new fiscal rule, essentially a looser cap allowing real spending increases depending on revenue growth. The government has not met its nominal deficit targets, and year after year, certain expenditures have been excluded from the calculation to allow compliance with the rule. If targets were not met, some automatic triggers would be activated.
The funniest part is that everything looks fine and perfect. Unemployment is at a historic low, the exchange rate has appreciated, and inflation is falling (though still above the target ceiling since he took office in 2023). And the market doesn’t seem rattled. Brazil is a ticking time bomb that never explodes.
I'm Brazilian. A similar process occurred around the last election (2021): Bolsonaro implemented a fiscal expansion, and after Lula was elected, they revised Temer’s fiscal rule to increase the federal government's fiscal capacity. We saw inflation above target in each of the last three years, and in 2025, it's projected to be right at the top of the target range.