South-Western College Publishing - Economics  
Real Problems in Brazil
Subject International monetary policy
Topic International Finance
Key Words International Monetary Policy, Currency Devaluation, Mercosur
News Story

Mercosur is South America's equivalent of the European Union. Member countries include Brazil, Paraguay, Argentina and Uruguay, making Mercosur the third largest trading bloc in the world. When economic problems forced Brazil to devalue its currency, the real, by more than 40 percent in January 1999, this action created new tensions and raised old issues for Brazil's trading partners. It has also raised the issue of what currency policy Mercosur should adopt

Brazil is the largest economy in Mercosur with a gross domestic product (GDP) that is twice that of the other countries combined. Consequently, the drop in Brazil's prices as a result of its devaluation had widespread impact on the other economies. Argentina, the region's largest beef producer, is now importing beef from Brazil and Uruguay's exports of textiles, wools, and grains to Brazil have dropped by 20 percent. Argentina is claiming that Brazilian steel producers are dumping steel in their country. Brazil's Mercosur partners have asked Brazil for concessions on some trading issues, something Brazil is reluctant to do.

The crisis has also precipitated an issue concerning the appropriate currency policy for Mercosur. While Argentina pegs its peso to the dollar, a policy that imposes strict fiscal discipline on the economy, Brazil allows its currency to freely float in the foreign exchange market.

(Updated July 1, 1999)

Questions
1. What is a currency devaluation?
2. What are some of the factors that would cause the exchange rate for the real to fluctuate?
3. How can the central bank of Brazil limit the fluctuations in the real?
Source Larry Rohter, "Brazil Devaluation Changes the Trading Bloc Picture," The New York Times, June 1, 1999.

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