brazil - BRAZILIAN FINANCIAL CRISIS OF 1998-1999 1 After...

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BRAZILIAN FINANCIAL CRISIS OF 1998-1999 1
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After decades of chronic high inflation and debt crisis, the Brazilian economy finally lived through a period of stability, starting in July 1994 with the implementation of the Real Plan. In 1998- 1999, however, Brazil suffered a major balance of payment crisis, which forced the devaluation of its local currency, the “Real”, and the end of the crawling peg 1 Brazilian currency had in relation to the dollar. There are many theories that intent to explain the causes of financial crisis. Some authors argue that its origin lies in bad government policies implemented to sustain low inflation rates; others defend that financial crisis are initiated due to market panic; a third group argue that financial crisis in emerging markets are likely to happen due to financial contagion. The discussion of the causes of financial crisis is indeed academically important because its results may help preventing other crisis such as the one Brazil went through. The Brazilian financial crisis happened due to a combination of both contagion and market panic. De Paula and Alves’ theory defends that stabilization programs involving some variation of a fixed exchange rate ultimately promote external financial fragility. Their basic argument is that domestic stabilization policies are inherently destabilizing; and that those policies, although initially successful, may generate an endogenous process of economical deterioration, which may leave the country vulnerable to speculative attacks. In this context, high interest rates used to reinforce country’s economical attractiveness to investor may lead to an increasing public internal debt and a deterioration of fiscal balance; and greater appreciation of exchange rate can promote a boom in imports and a downturn in exports, which may lead to a current account deficit. According to this theory, current account deficit can only be sustained by equivalent levels of long-term capital inflow, associated with productive investments capable of generating growth. De Paula and Alves conclude arguing that a reversal in the capital flow (capital outflow) can lead to such a balance of payment crisis that will unable the government to maintain the exchange rate regime. 1 A crawling peg regime means that the local currency of the country is allowed to fluctuate within a formally established range that is periodically adjusted, which in turn, allows for a controlled devaluation of the domestic currency against the dollar. 2
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Chang, on the other hand, argues that although the Brazilian crisis occurred as a typical financial crisis, it was not preceded by conventional macroeconomic disequilibria. The country had, for instance, satisfactory growth rate, low inflation, and basically balanced fiscal accounts. According to Chang, these pre-conditions of Brazilian economy prior to the crisis go against Krugman’s prediction that a balance of payment crisis happen when a country has to abandon its fixed exchange
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This note was uploaded on 04/09/2008 for the course PHR 101 taught by Professor Kallman during the Spring '08 term at Bergen Community College.

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brazil - BRAZILIAN FINANCIAL CRISIS OF 1998-1999 1 After...

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