WHAT HAP­PENED TO BRAZIL’S ECON­OMY?

The coun­try seems to have been hit by a per­fect storm of bad global econ­omy and bad fiscal and mon­e­tary pol­icy

New Straits Times - - VIEWPOINT -

ITHINK I can now take some time off from Amer­i­can po­lit­i­cal cri­sis to talk about events else­where. So, what the hell hap­pened to Brazil? I’m ac­tu­ally not talk­ing about the re­cent elec­tion, in which Brazil’s vot­ers chose some­one who ap­pears to be an ac­tual fas­cist. I’m as hor­ri­fied as any­one else. How­ever, I have no knowl­edge what­so­ever of Brazil­ian pol­i­tics. On the other hand, the back­drop to that elec­tion was Brazil’s ex­tra­or­di­nary eco­nomic cri­sis of 2015-16: A na­tion that had been on an up­ward tra­jec­tory, that seemed to have shaken off the legacy of in­sta­bil­ity, suf­fered a ter­ri­ble re­ces­sion and is ex­pe­ri­enc­ing a very slow re­cov­ery. And macro­eco­nomics is a sub­ject I’m sup­posed to know some­thing about.

So what hap­pened? There has been sur­pris­ingly lit­tle in­ter­na­tional dis­cus­sion of the Brazil­ian ex­pe­ri­ence, even though it was very se­vere and Brazil is a pretty big econ­omy (gross do­mes­tic prod­uct at pur­chas­ing power par­ity about 10 times as large as Greece.) Maybe we’re all too dis­tracted by the po­lit­i­cal cri­sis in the West — Trump, Brexit, etc. Any­way, I’ve been try­ing to put to­gether a story of the Brazil­ian cri­sis, well aware that I may well be miss­ing im­por­tant as­pects.

Here’s what it looks like to me: Brazil ap­pears to have been hit by a per­fect storm of bad luck and bad pol­icy, with three main as­pects. First, the global en­vi­ron­ment de­te­ri­o­rated sharply, with plung­ing prices for the com­mod­ity ex­ports still cru­cial to the Brazil­ian econ­omy. Sec­ond, do­mes­tic pri­vate spend­ing also plunged, maybe be­cause of an excessive buildup of debt. Third, pol­icy, in­stead of fight­ing the slump, ex­ac­er­bated it, with fiscal aus­ter­ity and mon­e­tary tight­en­ing even as the econ­omy was headed down.

Maybe the first thing to say about Brazil’s cri­sis is what it wasn’t. Over the past few decades those who fol­low in­ter­na­tional macro­eco­nomics have grown more or less ac­cus­tomed to “sud­den stop” crises in which in­vestors abruptly turn on a coun­try they’ve loved not wisely but too well. That was the story of the Mex­i­can cri­sis of 1994-5, the Asian crises of 1997-9, and, in im­por­tant ways, the cri­sis of south­ern Europe af­ter 2009. It’s also what we seem to be see­ing in Turkey and Ar­gentina now.

We know how this story goes: the af­flicted coun­try sees its cur­rency de­pre­ci­ate (or, in the case of the euro coun­tries, its in­ter­est rates soar).

Or­di­nar­ily cur­rency de­pre­ci­a­tion boosts an econ­omy, by mak­ing its prod­ucts more com­pet­i­tive on world mar­kets. But sud­den-stop coun­tries have large debts in for­eign cur­rency, so the cur­rency de­pre­ci­a­tion sav­ages bal­ance sheets, caus­ing a se­vere drop in do­mes­tic de­mand. And pol­i­cy­mak­ers have few good op­tions: rais­ing in­ter­est rates to prop up the cur­rency would just hit de­mand from an­other di­rec­tion.

But while you might have as­sumed that Brazil was a sim­i­lar case — its nine per cent de­cline in real GDP per capita is com­pa­ra­ble to that of sud­den-stop crises of the past — it turns out that it isn’t. Brazil does not, it turns out, have a lot of debt in for­eign cur­rency, and cur­rency ef­fects on bal­ance sheets don’t seem to be an im­por­tant part of the story. What hap­pened in­stead?

First of all, the global eco­nomic en­vi­ron­ment took a big turn for the worse. Brazil has di­ver­si­fied some­what into man­u­fac­tures, but it’s still heav­ily de­pen­dent on com­mod­ity ex­ports, whose prices have plunged. Brazil’s terms of trade — the ra­tio of ex­port to im­port prices — took a ma­jor hit.

This would have been nasty in any case. But it went along with a sharp fall in do­mes­tic con­sumer spend­ing. Atif Mian and co-au­thors tell us that this was linked to a rise in house­hold debt over the pre­vi­ous few years — that, Brazil ex­pe­ri­enced some­thing more like the ad­vanced-coun­try debt de­fla­tion of 2008 than a tra­di­tional emerg­ing-mar­ket cri­sis.

What re­ally did Brazil’s econ­omy in, how­ever, was the way it re­sponded to th­ese shocks: with fiscal and mon­e­tary pol­icy that made things much worse.

On the fiscal side: Brazil has big long-term sol­vency prob­lems. But th­ese re­quire long-term so­lu­tions. What hap­pened in­stead was that the Roussef govern­ment de­cided to im­pose sharp spend­ing cuts in the mid­dle of a slump. What were they think­ing? In­cred­i­bly, it seems that they bought into the doc­trine of ex­pan­sion­ary aus­ter­ity.

And on top of that, mon­e­tary pol­icy also turned sharply con­trac­tionary, with a big rise in in­ter­est rates. What was that about?

As best I can fig­ure out, what hap­pened was that the real de­pre­ci­ated mainly be­cause of that terms of trade shock, send­ing in­fla­tion tem­po­rar­ily higher. And the cen­tral bank pan­icked, fix­at­ing on the in­fla­tion is­sue at the ex­pense of the real econ­omy. Now that the cur­rency-in­duced spike is over, in­fla­tion is ac­tu­ally low by his­tor­i­cal stan­dards, but the dam­age was done.

It’s a remarkable and de­press­ing story. And this com­bi­na­tion of bad luck and bad pol­icy surely played a role in the po­lit­i­cal dis­as­ter that fol­lowed.

What re­ally did Brazil’s econ­omy in, how­ever, was the way it re­sponded to th­ese shocks: with fiscal and mon­e­tary pol­icy that made things much worse.

The writer is a No­bel Prize win­ner and op-ed colum­nist for ‘The New York Times’. He is also distin­guished pro­fes­sor of Economics at the Grad­u­ate Cen­ter of the City Univer­sity of New York

NYT PIC

Brazil­ians line up to cast their vote for pres­i­dent last month.

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