After all, are we living in a world of floating rates or fixed rates? Normally, analysts take for granted that since 1973 the world has been living with floating rates. By the same token, one normally considers that 1947-1973 was a period of fixed (but adjustable) exchange rates, in contrast to the gold standard of the first decades of the 20th century, particularly 1900-1930.
In 2010, Brazilian real GDP should grow by more than 7%, maybe reaching 8%, or even more than that. Between 1987 and 2009, that is, for more than 20 years, Brazil grew at very low rates, quite inferior to 7%, having sometimes negative growth—at least four times: 1988 (minus 0.5%), 1990 (minus 4.3%), 1992 (minus 0.5%) and 2009 (minus 0.2%). Therefore, at the moment, we have a “Brazilian miracle” of one year only—a “samba of one single note” as the famous song says. It should be noticed that, in those 20 years, we went from President Jose Sarney to President Lula, passing through Fernando Collor, Itamar Franco and Fernando Henrique Cardoso.
A tragedy is happening in Brazil as far as fiscal policy is concerned and nobody is paying too much attention.
Although inflation and “monetary correction” have practically disappeared in Brazil since 1995, the country continues to use a strange concept to measure the behavior of fiscal policy: the “primary surplus”. This is the difference between government revenues and government expenses without including one major expense: nominal interest payments.
Many economic analysts tend to praise the present Brazilian macroeconomic policy with floating exchange rates, government primary surpluses and inflation targeting. Only a few dedicate their time to call attention to the serious problems and risks, which are building themselves precisely because of this “triple” approach to economic policy.
The economic statistics indicate that such policies are simply destroying exports of manufactured and semi-manufactured goods as well as almost doubling in a 12-month period the amount of imports of goods (80% growth in contrast to 8% GDP growth). Furthermore, nominal and real interest rates are excessively high: the record levels for real interest rates as a matter of fact produce further exchange rate appreciation.
The rapid growth of current government expenditures in many countries is clearly behind the explosive increase in the ratio “government debt/GDP”. From the BRICs to Southern Europe, economic analysts are beginning to discuss the conditions for a negative fiscal multiplier.
In other words, in spite of the famous identity Y = C(p) + I(p) + C(g) + I(g) + X – M, one might have many situations where an increase in C(g) financed by government bond issues has a negative impact on the other variables of the identity, including private consumption, private investment, Government investment and the current account balance surplus.
The Phillips Curve was presented in the mid-fifties by the Australian economist A. W. Phillips: a trade-off between inflation and unemployment, that is, a negative correlation between inflation and unemployment. Ten years later, in the mid-sixties, the American economist Arthur Okun developed the so-called Okun’s Law: a positive relation between unemployment and the “output gap” concept, which was defined as the distance between potential GDP and actual GDP measured in percentage terms.
One of the major economic policy discussions in the Brazilian Presidential campaign will certainly be the relationships and dilemmas between the level of the exchange rate and the level of nominal interest rates. The opposition argues that the country is presently in a trap, where a very high level of real and nominal interest rates is being maintained, under the inflation targeting regime, and contributing to produce an overvalued exchange rate.
The excellent book Lords of Finance shows very clearly what happened with the major Central Bankers of the world during the Great Depression. In other words, for many different reasons – but mainly because of the fear of inflation or hyperinflation – the behavior of monetary aggregates and interest rates in the period 1929-1933 was entirely inconsistent with the dramatic declines of real economic activity. Only after Milton Friedman and Anna Schwarz wrote their classical monetary analysis of the Great Depression it became clear that there were major failures in the monetary policy responses to the economic crisis of the thirties.
In the past few years, a new theory is being developed with respect to the level of the exchange rate under a system of freely floating exchange rates or even under fixed rates. More and more, economists are explaining situations of overvaluation or undervaluation of the exchange rate of a country through a direct link with domestic savings. To use two excellent examples: it is argued that China can sustain an undervalued exchange rate because the country has a huge level of domestic savings; in contrast, the exchange rate would tend to be overvalued in Brazil because of the very low level of domestic savings.
After the financial and banking crisis of 2007/2008, the year of 2010 will certainly be dominated by the following global macroeconomic themes:
a) the growing importance in the world economy of Brazil, Russia, India and China – the so-called BRIC countries – with excellent perspectives, as far as their impact on world economic growth is concerned;
b) the dangerous fiscal and/or balance-of-payments situation of Portugal, Ireland, Italy, Greece and Spain – the so-called PIIGS countries – bringing serious risks for the world economy, including a renewed credit crunch;
c) the contradictory economic policies of the G-5 “big” economies ( US, UK, Germany, Japan and France).