Routledge Handbook of the History of Global Economic Thought by Barnett Vincent;

Author:Barnett, Vincent;
Language: eng
Format: epub
ISBN: 1775346
Publisher: Taylor and Francis

The end of ISI and inflation

Brazil’s expansion was debt-led, with foreign liabilities largely issued in dollar-denominated assets. ISI created pressures on the balance of payments, as the irony of import substitution was an initial surge of imports of intermediate capital to fabricate the finished product. At the time Brazil was also dependent on oil imports, so the quadrupling of oil prices in the 1970s weighed heavily on its external balance. Given the large internal market, industries responded to the incentives under ISI and the economy grew at robust rates nearing 8 percent until 1980.

Engineer and self-taught economist Mário Henrique Simonsen (1935–97) helped preside over the robust growth engineered by successive military governments by marrying market commitments with statist intervention (Schroy, 2013). Two of Simonsen’s most important contributions to economics were a cash-in-advance model of the demand for money, and the novel concept of inertial inflation. Both were at least partly linked to the experience of the Brazilian economy. Inertial inflation referred to the “feedback element” of the inflationary process, as opposed to other more conventional autonomous components such as supply shocks or excess demand. Inertial inflation could be generated by adaptive expectations, indexation processes, or as developed by Simonsen, a reduction in the inflation adjustment interval as price changes gathered pace.

Simonsen broke inflation down into three components: autonomous (picking up exogenous shocks), demand (including government policy), and a feedback variable where past inflation fueled current rates (Cabello, 2013). Simonsen cast Brazilian inflation dynamics in a structuralist light. Rather than simple rational expectations approaches to inflation, he observed that various parties – government, labor and industry – began acting in an uncoordinated fashion to raise interest rates, wages, and prices in anticipation of inflation. Therefore an increase in the interest rate could have unintended effects that debilitated traditional monetary policy. In a normal case an interest rate rise should signal a tightening of the money supply and a subsequent reduction of inflation. But the observed interest rate was seen by Simonsen as having two parts: real plus expected inflation. In this case an increase in interest rates was not a mark of monetary tightening but its opposite, an inflationary momentum. With inertial inflation, agents instead interpreted this as a signal that the central bank was trying to protect returns.

Simonsen also applied game theory models to the wage/income indexation processes at work in inertial inflation. He appreciated the cash-in-advance microeconomic model which posited that money was demanded because it was the only means of purchasing some goods. The paradox in high inflation economies like Brazil was that holding cash was a guaranteed means of losing wealth. The wealthy therefore kept their money in interest bearing “overnight” checking accounts, whereas the poor lost purchasing power due to lack of access to banks.

The high Brazilian comfort-level with theoretical contradictions, such as Simonsen’s “monetarist-structuralist” approach to inflation, allowed some conservative economists to ally with nationalists in the military government, to expand the role of the state in defending free market ideology. Unfortunately, the tensions within the mixed model turned out to be too great when hit with external shocks in the 1970s and 1980s.

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