Problem:
The president of Brazil has just appointed you to work with the country's cabinet ministers to launch a radical restructuring of the Brazilian economy. Inflation is running at over 1,000% annually, and the federal government is running a deficit in excess of 10% of GNP (the U.S. deficit is about 3% of GNP). To finance the deficit, the government has incurred huge debts, both internally and externally. In your initial discussions with the cabinet ministers, you realize that there is considerable disagreement about a number of specific program proposals.
Your job is to assess the issues and the relative merits of the proposed policies:
1) The Governor of the Banco do Brasil, Brazil's central bank, wants to cease its purchases of government bonds issued by the Ministry of Finance to fund the ongoing federal budget deficit. The Banco do Brasil has acquired 50% to 60% of all government bonds issued in the past several years with money expressly created for that purpose. In other words, it has been monetizing the deficit. Other cabinet ministers are afraid that this policy will lead to higher interest rates and wonder how the deficit can be financed otherwise.
2) The Minister of Infrastructure has proposed that his ministry begin privatizing the hundreds of state owned enterprises under his administration. These enterprises include virtually all of Brazil's steel industry, mining industry, electric utilities, the telephone company, national oil company, chemical companies, and a wide range of manufacturers. Opponents claim that this move will lead to massive unemployment and the bankruptcy of vital national industries.
3) The Minister of Political Economy has proposed that Brazil enter into free trade agreements with its Latin American neighbors. This would involve eliminating all tariffs, duties, and fees on imports. A number of other government leaders oppose this move, because the Brazilian market is larger and generally more protected than those of its neighbors. They feel that opening the border would expose Brazil to rapid growth in imports that exceed any incremental export activity.
4) The Minister of Finance has proposed creating a new consumption tax and lowering income tax rates. His concern is that Brazil's personal savings rate has been close to zero over the past several years. He believes increased savings will help to dampen inflation, lower interest rates on the federal debt, and promote exports. Critics of this proposal argue that the vast majority of Brazil's population are living very near the poverty line and that a consumption tax would be highly regressive (hit the poor relatively harder than the rich). It also would tend to dampen domestic demand, the principal engine of economic growth in Brazil.
5) The Minister of Labor has proposed raising the minimum wage to raise the income of poor workers and, thereby, offset the effects of restructuring on them. Other cabinet members are concerned about the effects this policy will have on employment and competitiveness.
6) The Central Bank has proposed that it replace the current fixed exchange rate system with a freely floating exchange rate system. Critics of this proposal argue that floating the real will devalue the currency and raise the cost of living (by boosting the price of imported necessities) for Brazilians.
7) To reduce the money supply and, thereby, suppress inflation, the Minister of Finance has proposed freezing all bank accounts. Depositors will be able to withdraw only the real equivalent of about $1,000. However, other cabinet ministers are concerned about possible adverse consequences of such a freeze.