10/11/2018 Opinion | What the Hell Happened to Brazil?

(Wonkish) - The New York Times

What the Hell Happened to

Brazil? (Wonkish)
How did an up-and-coming economy suffer such a severe slump?

By Paul Krugman
Opinion Columnist

Nov. 9, 2018

I think I can now take some time off from the U.S. political crisis to talk about events
elsewhere. So, as the headline says, what the hell happened to Brazil?

I’m actually not talking about the recent election, in which Brazil’s voters chose someone who
appears to be an actual fascist. I’m as horrified as anyone else. However, I have no knowledge
whatsoever of Brazilian politics. On the other hand, the backdrop to that election was Brazil’s
extraordinary economic crisis of 2015-16: A nation that had been on an upward trajectory, that
seemed to have shaken off the legacy of instability, suffered a terrible recession and is
experiencing a very slow recovery. And macroeconomics is a subject I’m supposed to know
something about.

So what happened? There has been surprisingly little international discussion of the Brazilian
experience, even though it was very severe and Brazil is a pretty big economy (G.D.P. at
purchasing power parity about 10 times as large as Greece.) Maybe we’re all too distracted by
the political crisis in the West — Trump, Brexit, etc. Anyway, I’ve been trying to put together a
story of the Brazilian crisis, well aware that I may well be missing important aspects.

Here’s what it looks like to me: Brazil appears to have been hit by a perfect storm of bad luck
and bad policy, with three main aspects. First, the global environment deteriorated sharply,
with plunging prices for the commodity exports still crucial to the Brazilian economy. Second,
domestic private spending also plunged, maybe because of an excessive buildup of debt. Third,
policy, instead of fighting the slump, exacerbated it, with fiscal austerity and monetary
tightening even as the economy was headed down.

Maybe the first thing to say about Brazil’s crisis is what it wasn’t. Over the past few decades
those who follow international macroeconomics have grown more or less accustomed to
“sudden stop” crises in which investors abruptly turn on a country they’ve loved not wisely
but too well. That was the story of the Mexican crisis of 1994-5, the Asian crises of 1997-9, and,
in important ways, the crisis of southern Europe after 2009. It’s also what we seem to be
seeing in Turkey and Argentina now.

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We know how this story goes: the afflicted country sees its currency depreciate (or, in the case
of the euro countries, its interest rates soar). Ordinarily currency depreciation boosts an
economy, by making its products more competitive on world markets. But sudden-stop
countries have large debts in foreign currency, so the currency depreciation savages balance
sheets, causing a severe drop in domestic demand. And policymakers have few good options:
raising interest rates to prop up the currency would just hit demand from another direction.

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But while you might have assumed that Brazil was a similar case — its 9 percent decline in
real G.D.P. per capita is comparable to that of sudden-stop crises of the past — it turns out that
it isn’t. Brazil does not, it turns out, have a lot of debt in foreign currency, and currency effects
on balance sheets don’t seem to be an important part of the story. What happened instead?

First of all, the global economic environment took a big turn for the worse. Brazil has
diversified somewhat into manufactures, but it’s still heavily dependent on commodity
exports, whose prices have plunged. As Figure 1 shows, Brazil’s terms of trade — the ratio of
export to import prices — took a major hit.

Figure 1 World Bank

This would have been nasty in any case. But it went along with a sharp fall in domestic
consumer spending (Figure 2). Atif Mian and co-authors tell us that this was linked to a rise in
household debt over the previous few years — that, Brazil experienced something more like

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10/11/2018 Opinion | What the Hell Happened to Brazil? (Wonkish) - The New York Times

the advanced-country debt deflation of 2008 than a traditional emerging-market crisis.

Figure 2 FRED

What really did Brazil’s economy in, however, was the way it responded to these shocks: with
fiscal and monetary policy that made things much worse.

On the fiscal side: Brazil has big long-term solvency problems. But these require long-term
solutions. What happened instead was that the Roussef government decided to impose sharp
spending cuts in the middle of a slump. What were they thinking? Incredibly, it seems that
they bought into the doctrine of expansionary austerity.

And on top of that, monetary policy also turned sharply contractionary, with a big rise in
interest rates (Figure 3). What was that about?

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Figure 3 FRED

As best I can figure out, what happened was that the real depreciated mainly because of that
terms of trade shock, sending inflation temporarily higher (Figure 4). And the central bank
panicked, fixating on the inflation issue at the expense of the real economy. Now that the
currency-induced spike is over, inflation is actually low by historical standards, but the
damage was done.

Figure 4 FRED

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It’s a remarkable and depressing story. And this combination of bad luck and bad policy surely
played a role in the political disaster that followed.

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Paul Krugman has been an Opinion columnist since 2000 and is also a Distinguished Professor at the City
University of New York Graduate Center. He won the 2008 Nobel Memorial Prize in Economic Sciences for
his work on international trade and economic geography. @PaulKrugman

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