South-Western College Publishing - Economics  
ABCs -- A Brazilian Cash and Credit Crunch
Subject Devaluation
Topic International Finance
Key Words Savings, Wealth Effect, Personal Income, Disposable Income, Capital Growth
News Story

The global financial crisis that started in the Far East has spread to Brazil. Brazil's economy is in recession and the impact of the recession may result in Brazilian workers receiving part of their compensation in goods instead of cash. The difficulty that Brazilian firms are having generating the cash to pay their workers is the result of a decision by the Brazilian government to support the Real and not devalue.

Recession has hit the Brazilian economy hard. Unemployment is about 19 percent in Sao Palo and averaging 8 percent elsewhere. The current account deficit is $32 billion, or 4 percent of gross domestic product, but the government has been reluctant to devalue. Government officials claim that any devaluation will bring back an era of hyperinflation and indexing which Brazil has fought hard to eliminate. Instead, the government plans to increase taxes and reduce government spending by $20 billion and receive a $30 billion bailout from the International Monetary Fund to support the nation's financial system. In the meantime, interest rates on business loans range from 40 to 50 percent and banks are lending to consumers at 120 percent interest. Business loans, available only to the most creditworthy, are difficult to come by.

Credit is not the only thing in scarce supply. Because workers in Brazil are typically paid every 4 weeks, workers get an extra--or 13th month--payment at the end of the year. In the face of reduced revenues and a credit crunch Brazilian firms are considering paying the 13th month payment in goods rather than cash. Of course, workers are not happy with this proposal. They will have some difficulty converting the goods into cash. The proposal is also looked at as a harbinger of even worse times to come.

(Updated December 1, 1998)
Questions

1. What is deflation? How should it be defined?
2. If productivity increases, can wages increase without an increase in prices? Explain your answer.
3. Suppose that the Federal Reserve wanted to increase the money supply in the face of a deflation. How could the Fed accomplish this?

Source Diana Jean Schemo, "In a Straitened Brazil, Talk of Pay in Goods", The New York Times, October 22, 1998.

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