Inflation in Brazil—the Principles of Monetary Correction

Summary

This Forum of Free Enterprise booklet reproduces Roberto de Oliveira Campos’s inaugural Chairman’s lecture, delivered at the London Stock Exchange on 19 November 1974 and published in Bombay in October 1975. Campos, a former Brazilian Minister of Finance and then Ambassador to the United Kingdom, sets out the rationale and architecture of Brazil’s policy of generalised monetary correction — that is, indexation — as a tool for living with chronic inflation rather than eradicating it. He opens with a diagnosis of the inflationary malaise afflicting the industrial West after 1971: money has lost its functions as store of value and unit of account, inflation is now structurally embedded in modern social structures, the conventional medicine of monetary and fiscal policy produces stagflation, and even mature democracies feel the political strain of two-digit price rises.

From this diagnosis Campos draws a heterodox conclusion. Because shock-treatment risked wrecking the entrepreneurial class and provoking a political backlash, Brazil after 1964 chose gradualism, attacking instead the five textbook ‘evils of inflation’: erosion of savings, wage disorder, balance-of-payments disequilibrium, disincentive to long-gestation investment, and tax-system distortions. Between 1964 and 1967 a battery of devices was implanted to neutralise each of these: generalised indexation of all forms of saving and medium- and long-term loans; a statutory wage formula combining a 12- to 24-month real-wage average with a productivity coefficient and a ‘half-the-expected-inflation’ residual; a tax reform that revalued capital assets and indexed the exemption threshold for low-income groups; and a ‘crawling-peg’ mini-devaluation regime tied to internal wholesale prices.

The author then weighs the results. Inflation, he reports, fell from roughly 100% in early 1964 to between 15 and 20% in 1972–73, while real growth ran above 10% a year, exports quadrupled and foreign-exchange reserves moved from $6.4 billion in deficit to almost $5.5 billion despite the oil shock. He stresses that indexation is exportable only with caveats — it presupposes ingrained inflationary expectations, a constitutional balanced-budget rule, and political tolerance for the wage formula — and warns repeatedly against overclaiming. Indexation, he concludes, neither cures inflation nor causes it; like a thermometer, it registers fever without producing it, and its real virtue is to preserve savings, investment incentives and democratic stability while the longer fight against inflation is fought. The booklet closes with the editorial disclaimer that the views are not necessarily those of the Forum.

Key points

• Frames post-1971 Western inflation as a structural ‘malaise’ that is unlikely to yield to conventional anti-inflationary shock treatment.

• Argues that the choice between ‘stop-go’ and stagflation has made gradualist cohabitation with inflation, not eradication, the realistic policy goal.

• Catalogues five textbook evils of inflation — savings erosion, wage disorder, BoP disequilibrium, investment disincentive and tax distortion — that Brazilian indexation was designed to neutralise.

• Describes the components of the Brazilian system: generalised indexation of savings instruments, the statutory wage formula, indexed tax reform, and the ‘crawling-peg’ exchange-rate mini-devaluation.

• Reports headline results: inflation falling from c.100% in 1964 to 15–20% by 1972–73, real growth above 10%, exports rising from $1.5bn to a projected $7.5bn, and reserves swinging from –$6.4bn to nearly $5.5bn.

• Identifies the preconditions for exportability of the Brazilian model — chronic inflation, a constitutional balanced-budget rule, wage-formula political viability — and is sceptical other countries can meet them.

• Insists indexation is not a cure for inflation but a means of preventing its worst distortions on savings, investment and income distribution.

• Traces the intellectual ancestry of indexation through William Fleetwood, Joseph Lowe, Jevons, Marshall, Irving Fisher and Keynes, citing Milton Friedman’s IEA Occasional Paper 41 as a contemporary reference.