Questions 1. How does Brazil hope to control its currentaccount deficit through a tight monetary policy? What alternatives are available to control

Questions

1. How does Brazil hope to control its currentaccount

deficit through a tight monetary

policy? What alternatives are available to

control Brazil’s current-account deficit?

2. How will Brazil’s tight money policy affect its

fiscal deficit? How will it affect Brazil’s real

(inflation-adjusted) interest rates, both shortterm

and long-term rates?

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.

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?

7. What are the tradeoffs that President

Cardoso must consider in deciding whether

to accelerate the real’s depreciation?

8. Could Brazil have avoided the recessionary

impacts of its monetary policy if it had

devalued the real instead?

9. What would a Brazilian devaluation do to

the currencies and economies of Argentina

and Chile, its neighbors and largest trading

partners?

10. What is the link between Brazil’s budget

deficits and its historical hyperinflation?

11. What mix of fiscal and monetary policy

would you recommend to President

Cardoso? Should he devalue or defend the

real?

Exhibit I 2.5 Brazilian Interest Rates

70%

60%

50%

40%

30%

20%

10%

0%

Percentage

1994 Dec

1995 Feb

1996 Feb

Feb

Apr

Jun

Aug

Oct

Dec

Apr

Apr

Jun

Jun

Aug

Aug

Oct

Oct

Dec

Money-market rate

Long-term interest rate

Source: Central Bank of Brazil Bulletin, April 1998.