the Brazilian economy and the effects of inflation

Topics: Inflation, Monetary policy, Supply and demand Pages: 9 (2518 words) Published: April 21, 2014
Chanelle Booysen

ECO2004S Essay

The Brazilian economy and the effects of Inflation
The global economy is growing at a much slower pace than previously forecasted by the IMF World Economic Outlook (WEO) due to underperformance in global emerging economies, such as Brazil, Russia, India and China (BRIC). Brazil suffered the biggest GDP downgrade during 2012 and as a result the IMF decided to alter the outlook of the Brazilian economy’s growth for 2013 and 2014 (Anon., 2013). Additionally inflation has increased which led to a decrease in living standards of citizens worsened by protests demanding better services in the economy (Flannery 2013). This essay will show using the AS-AD model; accompanied by explanations of what is happening in the financial and goods market along with the labour market to illustrate the effect of inflation in these sectors and the economy as a whole. Further this essay will deliver a clear walk through policies that were implemented in Brazil from 2010 till 2013 which so far had tepid effects. Lastly it will reveal the logic behind the IMF’s decision to downgrade the forecasts of GDP growth in Brazil during 2013 and 2014.

For a decade the Brazilian economy has experienced reasonable growth, lifting over 40 million people out of poverty into the middle class since 2003 and sustainable low unemployment rate of 5.8% (Langevin 2013). Brazil is the world’s seventh richest economy with a Gross Domestic Product (GDP) of US$ 2.4 trillion in 2012 (Langevin 2013). It is also the largest country in area and population in Latin America and the Caribbean. In 2010 the Brazil economy grew at a rate of 7.5% in terms of human capital and physical capital, faster than other emerging economies such as Mexico whose growth only approached 2% ( Langevin 2013). The economy benefitted from this as the boom resulted in increased investments from 15% to 19%, in 2010 (Langevin 2013). The Brazil economy however, was growing too fast above its potential due to high international demand for commodity and industrial production causing inflation to reach 5.91% above the government’s target of 4.5% (Langevin 2013). According to Blanchard (2009), given that output increases demand for goods will increase and as a result money demand and aggregate expenditure increases (Blanchard 2009). The increase in money demand causes an excess demand for money (increasing loans) which causes banks to increase interest rates. The IS-LM is a useful model that can be used to describe dynamics in the financial market and goods market. In the IS-LM model –illustrating the relationship between interest rates and real output in the

Chanelle Booysen

ECO2004S Essay

goods and financial market-the increase in output (Y) causes the IS curve to shift right which causes interest rates to increase through a upward movement along the LM curve (Blanchard 2009). This causes a shift of the aggregate demand curve that leads to increasing prices as production shortages increase. The effect of the increasing interest rates had an offset effect on GDP due to falling investments which affected GDP such that the net effect resulted in smaller growth. As a result of too much growth in 2010, the government implemented a fiscal contractionary policy to stabilize inflation (Romero 2011) during 2011. In 2012 Brazil’s growth was much smaller than the WEO forecasted which affected Brazil’s very low unemployment rate of 5.8% during this period due to high inflation (Bruno and Easterly 1998). As much as the Brazil economy did grow, growth was not enough to reduce inflation and sustain the real wage of all middle class and lower class people (Langevin 2013).

Figure 1: The Brazil economy during 2011 and 2012. Assumption: In this graph lower than expected growth is associated with production below natural level of employment.

Chanelle Booysen

ECO2004S Essay

The AS-AD model expresses the relationship between output and...
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