8

Inflation Targeting in Emerging

Countries: The Case of Brazil
Philip Arestis
University of Cambridge

Luiz Fernando de Paula

University of the State of Rio de Janeiro and CNPq

Fernando Ferrari-Filho
Federal University of Rio Grande do Sul and CNPq

1 Introduction*

The purpose of this chapter is to examine Inflation Targeting (IT) in the case
of emerging countries by concentrating essentially on the case of Brazil. IT is
a new monetary policy regime (see, for example, Bernanke and Mishkin,
1997) that has been adopted by a significant number of countries (see, for
example, Sterne, 2002). Brazil adopted this economic policy framework in
June 1999. While the focus of this chapter is on Brazil, we also examine the
experience of other countries both for comparative purposes and for evi-
dence of the extent of success of this ‘new’ economic policy by other IT
countries. In addition, we compare the experience of Brazil with IT and
with that of non-IT countries, and ask the question of whether it makes a
difference in the fight against inflation whether a country has adopted
IT or not.
We proceed as follows: section 2 deals with the more theoretical aspects of
the IT framework. This is followed in section 3 by an examination of recent
stabilization policies in Latin America, and Brazil in particular. This enables
us to demonstrate how countries, and Brazil in particular, came to imple-
menting IT strategies. Section 4 concentrates on the Brazilian experience
with IT, while section 5 compares the Brazilian IT experience with that of
other ‘similar’ emerging countries. The latter group includes both countries
within Latin America and other countries outside Latin America. A final sec-
tion, section 6, summarizes and concludes.

116
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 117

2 Theoretical aspects of IT

There are a number of theoretical aspects that are the backbone of IT. We
examine the following two aspects: main theoretical elements, and certain
key operational aspects of IT. We begin with the first.

2.1 Main theoretical elements

This sub-section summarizes the main theoretical elements of IT. There are
six such elements as follows:1

(i) IT is a monetary policy framework whereby public announcement of

official inflation targets, or target ranges, is undertaken along with
explicit acknowledgement that price stability, meaning low and stable
inflation, is monetary policy’s primary long-term objective (King, 2002).
The price stability goal may be accompanied by output stabilization so
long as price stability is not violated. Explicit numerical target for infla-
tion is published, either as a point or a range, and a time horizon for
reaching the inflation target. Such a monetary policy framework
improves communication between the public, business and markets on
the one hand, and policymakers on the other hand, and provides discip-
line, accountability, transparency and flexibility in monetary policy. The
focus is on price stability, along with three objectives: credibility (the
framework should command trust); flexibility (the framework should
allow monetary policy to react optimally to unanticipated shocks); and
legitimacy (the framework should attract public and parliamentary sup-
port). In fact, credibility is recognized as paramount in the conduct of
monetary policy to avoid problems associated with time-inconsistency
(Barro and Gordon, 1983). It is argued that a policy, which lacks credi-
bility because of time inconsistency, is neither optimal nor feasible
(Kydland and Prescott, 1977; Calvo, 1978; Barro and Gordon, 1983).
(ii) A further role of IT is to ‘lock in’ the gains from ‘taming’ inflation.
Bernanke et al. (1999) are explicit on this issue, when they argue that ‘one
of the main benefits of inflation targets is that they may help to “lock
in” earlier disinflationary gains particularly in the face of one-time infla-
tionary shocks’ (p. 288). In an important contribution, though, Johnson
(2003) finds rather mixed results for this contention. Johnson (op. cit.)
compares actual forecasts with predicted forecasts undertaken by profes-
sional forecasters for five consecutive 12-month periods after the announce-
ment of inflation targets. The study isolates the additional effect of the
announcement of inflation targets on the level of expected inflation in the
case of Australia, Canada, New Zealand, Sweden and the UK. Immediate
reduction in expected inflation is registered in New Zealand and Sweden
with a smaller effect and slower impact in Australia and Canada; inflation
targets do not appear to have a significant impact in the UK.
118 Political Economy of Brazil

(iii) In this framework, monetary policy is taken as the main instrument of

macroeconomic policy. Fiscal Policy is no longer viewed as a powerful
macroeconomic instrument (in any case it is hostage to the slow and
uncertain legislative process); in this way, ‘monetary policy moves first
and dominates, forcing fiscal policy to align with monetary policy’
(Mishkin, 2000, p. 4). Monetary policy is a flexible instrument for achiev-
ing medium-term stabilization objectives, in that it can be adjusted
quickly in response to macroeconomic developments. Indeed, monetary
policy is viewed as the most direct determinant of inflation, so much so
that in the long run the inflation rate is the only macroeconomic variable
that monetary policy can affect. Monetary policy cannot affect eco-
nomic activity, for example output, employment, etc., in the long run.
(iv) Monetary policy should not be operated by politicians but by experts
(whether banks, economists or others) in the form of an ‘independent’
central bank. Politicians would be tempted to use monetary policy for
short-term gain (lower unemployment) at the expense of long-term loss
(higher inflation), the time-inconsistency problem (Kydland and
Prescott, 1977). An ‘independent’ central bank would also have greater
credibility in the financial markets and be seen to have a stronger com-
mitment to low inflation than politicians do. There is also the question
of instrument independence, when the monetary policy instrument is
under the control of the independent central bank, and goal independ-
ence, when the independent central bank sets the goal of monetary policy
(Debelle and Fischer, 1994; Fischer, 1994). It is argued that instrument
independence is preferable to insulate the independent central bank
from time-inconsistent policies. However, in terms of the goals of mon-
etary policy, it is thought that an independent central bank should be
goal dependent so that its long-run preferences coincide with society’s
preferences, i.e. elected government’s (Bernanke et al., 1999).
(v) A mechanism for openness, transparency and accountability should be
in place with respect to monetary policy formulation. Openness and
transparency in the conduct of monetary policy improve credibility. IT
central banks publish inflation reports that might include not only an
outlook for inflation, but also output and other macroeconomic vari-
ables, along with an assessment of economic conditions. There is also
some accountability mechanism: if the inflation target is not met, there
should be specific steps in place for the central bank to follow; this may
include publishing an explanation, or submitting a letter to the govern-
ment explaining the reasons for missing the target and how to return to it.
Furthermore, transparency reduces uncertainty about the central bank’s
preferences, which is expected to lead to lower expected rate of inflation.
(vi) In the case of inflation targeting in an open economy, exchange rate
considerations are of crucial importance, and we highlight this aspect in
the case of emerging countries, and Brazil in particular in what follows
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 119

in this chapter. They transmit both certain effects of changes in the policy
instrument, interest rates, and various foreign shocks. Given this critical
role of the exchange rate in the transmission process of monetary policy,
excessive fluctuations in interest rates can produce excessive fluctu-
ations in output by inducing significant changes in exchange rates. This
may suggest exchange rate targeting. However, the experience of a num-
ber of developing countries, which pursued exchange rate targeting but
experienced financial crises because their policies were not perceived as
credible, is relevant to the argument. The adoption of IT, by contrast,
may lead to a more stable currency since it signals a clear commitment
to price stability in a freely floating exchange rate system. This, of
course, does not mean that monitoring exchange rate developments
should not be undertaken. Indeed, weighting them into decisions on
setting monetary policy instruments is thought desirable. Such an
approach is thought to make undesirable exchange rate fluctuations less
likely, thereby promoting the objective of financial and price stability
(Bernanke and Gertler, 1999).

2.2 Operational aspects

In terms of the operational framework of IT, a number if issues suggest them-
selves. To begin with, there is the establishment of inflation targets. This is
the setting of a point target or a band and choosing the time period over
which the target is expected to be achieved. It is important to note that the
target horizon (over which the central bank is expected to achieve its infla-
tion target) cannot be shorter than the control horizon (over which the pol-
icy is expected to affect the target variable). Clearly, choosing a range as
opposed to a point for the inflation target contains a great deal of flexibility,
not only for output stabilization but also for accommodating large move-
ments in the nominal exchange rate; this is a particularly thorny issue in the
case of emerging countries, and Brazil in particular as shown below. In those
cases where a range is chosen, there is the question of symmetrical/asym-
metrical response with respect to the central target. Symmetrical behaviour
purports to show equal concern for both inflation and deflation. Such an
approach reduces the likelihood of output declines and deflation, and indi-
cates that the central bank cares about output fluctuations; this helps to
maintain support for its independence. An asymmetric approach to inflation
targeting may be advantageous when high inflation rates threaten credibil-
ity. This is often the case for developing and emerging countries adopting
inflation targeting. A greater weight on overshoots than undershoots in the
loss function is suggested under these circumstances.
IT also requires the setting up of a model or methodology that can provide
information on future inflation, an issue that relates to the necessity of fore-
casting inflation. There is also the key issue of how to measure inflation.
A relevant question in this context is whether the chosen price index should
120 Political Economy of Brazil

reflect the prices of goods and services for current consumption only, or for
both current and future consumption. In the latter case constructing such a
price index is, of course, not feasible. Then there is the problem of noisy or
erratic short-run movements in prices, which suggests that an adjusted or
core (long-term) price index should be used. Such an index might exclude
from the general or headline price index items such as food and energy
prices, shocks to the exchange rate, indirect tax or regulated prices on the
assumption that such changes are the result of temporary and self-correcting
short-term shocks that contain very little information on long-term price
movements. Another important excluded category of items relates to changes
directly associated with the policy change. Items, which vary directly with
the policy instrument, such as mortgage payments, may be excluded from the
definition of the targeted price index. Such effects, however, may contain
significant and protracted second-round effects. For example, a rise in indirect
taxes that lowers inflation temporarily, can affect aggregate demand, which
may lower prices in the long run, thereby implying important loss of infor-
mation on future price developments.
There is still the question of the trade-off between reducing deviations of
inflation from target, and preventing a high degree of output variability. This
is particularly pertinent in the case of supply shocks that cause inflation to
exceed the target and are associated at the same time with lower output.
Monetary authorities have a serious dilemma in these circumstances: the
quicker the disinflation, the shorter the period of actual inflation being above
its target. But then the quicker disinflation is, the greater the potential output
variability. Policy preferences is an important determinant of this trade-off
in addition to the magnitude of the supply shock. Flexibility is required in this
context, which, however, may conflict with credibility if agents interpret it
as reluctance by the central bank to deflate. There is, thus, another trade-off
in this case between credibility and flexibility (Garfinkel and Oh, 1993).
This discussion highlights another important operational aspect. This relates
to the question of monetary rules. Central banks on the whole are assumed to
follow one form or another of Taylor Rules (Taylor, 1993). In its original formu-
lation this monetary rule took the ad hoc formulation as shown in equation (1):

Rt ⫽ RR* ⫹ pT ⫹ d1Y gt ⫹ d2(pt⫺1⫺pT) (1)

where the symbols are as follows: R is the rate of interest used for monetary
control purposes, pT is desired inflation in the original Taylor (op. cit.) for-
mulation (in current parlance it is the inflation target set by the central
bank), Yg is output gap (i.e. the difference between actual and potential out-
put), and p is actual inflation. Equations of the type depicted in (1) are what
is called Taylor rules, since Taylor (1993) who showed that a simple equation
of this form, with d1 ⫽ 0.5 and d2 ⫽ 1.5, captures surprisingly well the
behaviour of the US federal-funds rate and the Federal Reserve System (Fed)
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 121

monetary policy. The nominal rate is increased more than one-to-one with
respect to any increase in inflation. This policy reaction ensures that the real
rate of interest will act to lower inflation. Given inflation, the real rate of
interest is also increased as a result of output-gap positive changes. Taylor
rules, therefore, require monetary policy to act automatically to inflation
and output. These Taylor-type rules have been criticized (for example,
Svensson, 2004) in terms of the possibility of real indeterminacy: if the rise
in the nominal rate of interest in response to a rise in expected inflation is
not high enough, then the real rate of interest falls raising demand which
fails to check inflation. Mutatis mutandis, an excessive rise in the nominal
rate of interest in response to a rise in expected inflation would also cause
indeterminacy. However, indeterminacy can be avoided if monetary author-
ities respond rather aggressively, that is with a coefficient above unity to
expected inflation, but not overly higher than unity. This result has been
demonstrated in the closed-economy case (Clarida et al., 2000) as well as in the
small open-economy case (De Fiore and Liu, 2002).

3 The Brazilian experience: from the exchange

rate anchor to IT

Stabilization policies in Brazil, and more generally in Latin American coun-

tries, in the 1990s were based on some form of exchange rate anchor.
Liberalization of the trade, financial and capital accounts was thought para-
mount. The experience with those programmes showed that although they
were successful in ending the history of chronic high inflation, they showed,
nonetheless, that local currency appreciation as a result of favourable differ-
entials between domestic and foreign prices, was causing balance of pay-
ments disequilibria. A new problem emerged, which was closely related to
the endeavour to achieve and maintain balance of payments equilibria. That
was the use of high interest rates by monetary authorities to attract foreign
capital. The need to maintain high interest rates in order to attract foreign
capital increased public internal debt (monetary authorities had to sterilize
the inflow of foreign capital), which deteriorated economic performance
and fiscal balances. Under those conditions in a global world where financial
and productive capital are mobile, the successful application of an internal
stabilization policy generated an endogenous process of deteriorating eco-
nomic conditions. That, then, left Latin American countries vulnerable to
speculative attacks on their currencies, and thus subjected them to currency
crises (Kregel, 1999). The currency crises in Mexico (1994–95), in Brazil
(1998–99, and 2002), and in Argentina (2001–02), are some good examples
of this dynamic process. That unhappy experience of some Latin American
countries with pegged exchange rate regimes, and the associated era of deep
financial crises in the 1990s, led them to search for alternative nominal
anchors. Since at the same time more or less several industrial countries
122 Political Economy of Brazil

adopted the IT as a new monetary policy framework, it became an alternative

policy regime for countries in Latin America. In fact, IT was adopted by Chile
in 1990, Mexico in 1999, Colombia in 1999, Brazil in 1999, and Peru in 2002.
The Real Plan, in Brazil, was created on the same basis as the stabilization
programmes applied all over Latin America over the period of late 1980s to late
1990s. That system was characterized by a fixed or crawling-peg exchange
rate, in combination with a more open trade policy. The exchange rate was the
price anchor utilized throughout that period.2 During the exchange rate anchor
period, very high interest rates were targeted designed to attract short-term
foreign capital for balance-of-payments purposes. The volume of those cap-
ital flows was many times greater than the volume required for the needs of
the balance of payments, thus raising the level of foreign reserves and lead-
ing to a real appreciation of the exchange rate.3 That appreciation resulted in
significant balance of trade deficit. The effect of that liberal economic policy
arrangement aggravated Brazil’s external fragility and, consequently, the coun-
try had three speculative attacks on its currency over the three-year period
1995 to 1998. Furthermore, the Brazilian economy, from the third quarter of
1998 to the first quarter of 1999, was characterized by macroeconomic instabil-
ity, resulting in a sharp outflow of short-term capital. Thus, repeated financial
crises in a very short period of time, i.e. the South East Asian crisis and the
Russian crisis along with the international recession of 1997–98, contributed
to deteriorating the Brazilian economy. In fact, as a result of the effects of the
Russian crisis in particular, Brazil was forced to abandon its crawling-peg
exchange rate and adopted a floating exchange rate regime. The exchange
rate depreciated as a result, thereby producing significant price pass-through
effects with the inevitable adverse consequences on the inflation front.
Following the transition to a floating exchange rate, in January 1999,
Brazil adopted an IT regime, in June 1999, to keep inflation under control. At
the same time, the Central Bank of Brazil raised the basic short-term interest
rate to accommodate the currency depreciation shock. As a result, an appre-
ciation to the exchange rate occurred very fast and inflation, despite the
huge devaluation in the beginning of 1999, ended the year in single figures.

4 The Brazilian experience with IT

4.1 The institutional dimension

The Brazilian IT monetary policy regime is modelled on the basis of the British
IT model. The National Monetary Council (CMN)4 sets the inflation targets,
which are proposed by the Minister of Finance. The Central Bank of Brazil
Monetary Policy Committee (COPOM)5 has to achieve the inflation target
through the use of the short-term interest rate. In fact the Central Bank of Brazil
makes use of the Taylor rule as its reaction function. The relevant relationship is:

Rt ⫽ RR* ⫹ pT ⫹ g1Ygt ⫹ g2 (pt⫺1 ⫺ pT) ⫹ g3 (ert ⫺ ert⫺1) ⫹ g4 Rt⫺1 (2)

 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 123

where the symbols are as above, with the exception of er which stands for
the exchange rate. The Brazilian Taylor rule relates the interest rate to devi-
ations of expected inflation from the target, allowing also for some interest
rate smoothing (Rt ⫺ 1) and reaction to the output gap as well as movements
in the exchange rate (Minella et al., 2003, p. 11). The Brazilian IT regime sets
year-end inflation targets for the current and the following two years. Inflation
targets are based on the headline inflation index, i.e. extensive national con-
sumer price index (IPCA).6 A certain degree of flexibility is introduced through
defining IT within a range, which has varied between 2.0 or 2.5 percentage
points above and below the central point target. The other main reason for
the introduction of this flexibility is that it helps the Central Bank of Brazil
to achieve its inflation target in view of the serious supply shocks to which
the Brazilian economy is exposed.
The inflation target is fulfilled when yearly variation of the inflation index
is inside the set range. If inflation breaches the target set by the CMN, the
Governor of the Central Bank of Brazil is required to write an open letter to
the Minister of Finance explaining the reasons the target was missed, as well
as the measures proposed to bring it back to target, and the time period over
which these measures are expected to take effect. The interest rate target set
by the COPOM is the target for the Selic interest rate, the interest rate for
overnight interbank loans, collateralized by those government bonds that
are registered with and traded on the ‘Sistema Especial de Liquidação e
Custodia’ (SELIC). The Selic target is fixed for the period between its regular
meetings. The Governor of the Central Bank of Brazil, though, has the right
to alter the Selic interest rate target anytime between regular COPOM meetings
(once per month). This is made possible by the COPOM, which has the right
to introduce a monetary policy bias at its regular meetings, where the bias refers
to easing or tightening of monetary policy outside meetings. The COPOM
authorizes the Governor of the Central Bank to alter the Selic interest rate target
in the direction of the bias at anytime between regular COPOM meetings.
Eight days after each meeting, the Committee releases the minutes on the
Central Bank of Brazil website and to the press through the Central Bank of Brazil
press officer. The minutes provide a summary of the COPOM’s discussion and
decisions. At the end of each quarter (March, June, September, December),
the COPOM publishes the Central Bank of Brazil Inflation Report, which pro-
vides detailed information on economic conditions, as well as the COPOM’s
inflation forecasts upon which changes in the Selic interest rate are deter-
mined. The objective of this report is to inform the public and the market about
the goals, design and implementation of monetary policy.

4.2 Brazil’s experience with IT

Table 8.1 shows actual inflation and the targets for 1999–2005. From 1999
(when IT was introduced in Brazil)7 to 2002, the tolerance intervals were 2
percentage points above and below the central target; for 2003 and 2004 the
124 Political Economy of Brazil

intervals were enlarged to 2.5 percentage points. The inflation rate was 8.9
per cent and 6.0 per cent for targets of 8 per cent and 6 per cent in 1999 and
2000, respectively. The targets were within the acceptable range. However, in
2001 and 2002, several external and domestic shocks – such as domestic
energy crisis in Brazil, effects of 11th September 2001, the Argentine crisis,
and the confidence crisis related to the presidential election in 2002 – hit the
Brazilian economy with significant impacts on inflation. Indeed, the inflation
rate reached 7.7 per cent in 2001, 1.7 per cent above the target’s upper range,
and 12.5 per cent in 2005, more than 5 percentage points above the upper
range. According to Minella et al. (2003, pp.6–8), the exchange rate rose
20.3 per cent and 53.5 per cent in 2001 and 2002, respectively. As a result, in
2001, 38 per cent of the inflation rate can be explained by the exchange rate
depreciation, whereas for 2002 the contribution of the exchange rate stood
at 46 per cent.8 In 2003 the inflation rate was 9.3 per cent above the adjusted
target of 4.5 per cent, and outside the range of 2.5 per cent tolerance inter-
val.9 The high inflation in 2003 was due mainly to the inertial effect of 2002
high inflation, in spite of the maintenance of the conservative economic
policy with very high interest rates by the new President, Lula da Silva, from
the Workers’ Party. In 2004 IPCA was 7.6 per cent, only slightly less than the
upper range of the inflation target (8.0 per cent).
Examining Table 8.1 more closely, further comments are in order. It is
notable that over the period 1999–2005 IT targets in Brazil were within the
set range in three out of the seven years of the operation of this monetary pol-
icy strategy. The targets were missed in 2001, 2002 and 2003 (despite raising
the inflation target to 6 per cent from 4 per cent) by a substantial margin,
especially in 2002. On one different occasion (2004), the inflation target was
met only after it had been raised in early 2003 (note 9). It may, thus, be con-
cluded that IT in Brazil was not completely unsuccessful over the first seven
years of its implementation. This begs the question of comparing Brazil’s IT

Table 8.1 Brazil – inflation targets and headline consumer price index (IPCA)

Year Inflation target (%) Tolerance intervals ⴙ/ⴚ (%) IPCA (%)

1999 8.0 2.0 8.94

2000 6.0 2.0 5.97
2001 4.0 2.0 7.67
2002 3.5 2.0 12.53
2003 6.0* 2.5 9.30
2004 5.5* 2.5 7.60
2005 5.1 2.5 5.69

Note: *The original inflation target was 3.25% (tolerance interval of 2%) in 2003 and 3.75%
(tolerance interval of 2.5%) in 2004. Later BCB decided to change again to inflation target in
2003 to the maximum limit of 8.5%, that was known as ‘adjusted target.’
Source: Central Bank of Brazil.
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 125

performance with that of other emerging countries both within Latin

America and outside it, and also both with IT and non-IT countries. Section
5 is designed to conduct this exercise, and we turn our attention to it next.

5 Comparing the Brazilian experience with other

‘similar’ countries

This exercise is undertaken with the help of Tables 8.2–8.4, which contain data
that concern inflation and GDP (average, standard deviation and coefficient
of variation) of a group of emerging countries that have adopted IT and those
that have not adopted IT.10 Two groups of emerging countries are reported:
the biggest Latin American countries and some other emerging countries.
Long periods of high inflation (inflation above 50 per cent per year) in the
data have not been included, as for example in the case of Brazil before 1995
and Israel before 1986.11 Standard deviations and coefficients of variation
can be sometimes misleading, as for example in the case of China, where a
high inflation standard deviation is present, as a result of a sharp decline of
high to low inflation, although this country has had very low inflation since
the late 1990s. It is for this reason that we also report data on inflation in
Figures 8.6–8.8 on inflation for all countries included in the sample, and sep-
arated by countries that adopt IT, and those that do not adopt IT.12 These fig-
ures are very important for the analysis, since they report inflation trends in
each country. Figures 8.1–8.5 report relevant statistics for Brazil in order to
support the analysis on the recent performance of IT in this country.
The following observations are in order:

(a) Inspection of Tables 8.2–8.4 clearly shows that the fall of inflation is a
recent general tendency in emerging countries, whether or not they
adopt an IT regime (see, also, Figures 8.6–8.8). Although in all IT emerging
countries the rate of inflation declined after the adoption of IT, in most
of them the coefficient of variation increased (Table 8.2). It is also true
that countries that did not adopt IT experienced improvements around
the same time as IT countries (Tables 8.3–8.4). Indeed, some emerging
non-IT countries, such as China, India, Egypt and Malaysia, have had
inflation rates below 4 per cent per year in the last few years. For some
countries, China, India and Malaysia, the stability of the nominal exchange
rate has had an important role for price stabilization purposes. So, IT and
non-IT countries have experienced similar reductions in inflation in
recent years.13 Theory suggests that ‘flexible’ IT stabilizes both inflation
and output. However, there is no clear evidence that emerging countries
that adopt IT have had a better performance in GDP terms (both in terms
of output growth and GDP coefficient of variation) when compared with
the emerging countries that do not adopt IT reported in this chapter.
Indeed, China, India and Malaysia are among the countries that have
 126

Table 8.2 Emerging IT countries

Country Before IT After IT

Inflation GDP Inflation GDP

Average SD CV Average SD CV Average SD CV Average SD CV

Latin American countries

Brazil 9.71 9.06 0.93 2.58 1.76 0.68 8.88 2.42 0.27 1.78 1.56 0.88
Chile 20.45 5.94 0.29 4.50 2.99 0.66 8.01 5.83 0.73 5.64 3.56 0.63
Colombia 23.71 4.26 0.18 3.62 1.64 0.45 6.80 2.21 0.32 1.86 1.76 0.95
Mexico 20.76 9.37 0.45 3.43 3.60 1.05 8.41 4.97 0.59 2.36 2.77 1.17
Other emerging countries
Israel 23.43 12.18 0.52 4.43 12.18 0.52 7.07 4.43 0.63 3.86 2.99 0.77
Poland 29.74 11.16 0.38 5.23 1.74 0.33 6.21 4.39 0.71 5.18 5.41 1.04
Czech Republic 13.73 16.43 1.20 n.a. n.a. n.a. 3.88 3.69 0.95 1.80 1.72 0.95
Thailand 4.97 2.06 0.41 5.28 6.56 1.24 1.41 0.55 0.39 4.75 2.25 0.47
South Korea 6.18 1.71 0.28 7.46 1.98 0.27 3.49 2.28 0.65 4.17 5.98 1.44

Notes: SD ⫽ standard deviation; CV ⫽ coefficient of variation (SD/average) Before IT / After IT : Brazil: 1995–98/1999–2003; Colombia; 1989–98/
1999–2003; Mexico;1989–98/1999–2003;
Chile: 1981–90/1991–2003; Czech Republic:1988–97/1998–2003 (until 1992, data from Czechoslovakia);
Israel: 1986–91/1992–2003; Poland:1992–97/1998–2003; Thailand:1990–99/2000–03; South Korea:1988–97/1998–2003.
Source: IMF (2002, 2004)/IPEADATA for Brazil’s inflation/Polish Market Review, August 2003.
Table 8.3 Emerging non-IT countries

Country 1980–91 1992–2003

Inflation GDP Inflation GDP

Average SD CV Average SD CV Average SD CV Average SD CV

Latin American countries

Argentina 663.56 950.55 1.43 0.82 6.18 7.56 6.02 12.23 2.03 2.09 6.41 3.07
Uruguay 65.86 26.06 0.40 1.35 5.24 3.88 26.39 21.32 0.81 1.29 5.48 4.24
Venezuela 25.42 5.33 0.21 1.55 5.33 3.44 40.15 24.48 0.61 ⫺0.18 5.15 ⫺29.42
Other emerging countries
China* 10.16 7.78 0.77 9.23 3.93 0.43 6.00 8.40 1.40 9.76 2.44 0.25
Egypt** 18.19 3.27 0.18 5.14 2.26 0.44 6.69 4.71 0.70 4.62 1.37 0.30
India 9.52 2.58 0.27 5.46 2.20 0.40 7.50 3.83 0.51 6.09 1.35 0.22
Malaysia 3.63 2.78 0.77 6.44 3.35 0.52 2.96 1.33 0.45 6.02 5.61 0.93
Turkey 53.23 23.15 0.43 4.26 3.61 0.85 68.81 22.02 0.32 3.52 5.81 1.65
Russia n.a. n.a. n.a. n.a. n.a. n.a. 147.94 258.80 1.75 0.04 7.33 201.68
South Africa*** 14.64 1.96 0.13 1.92 3.03 1.58 7.94 2.47 0.31 2.23 1.70 0.76

Notes: SD ⫽ standard deviation; CV ⫽ coefficient of variation (SD/Average) * Data for inflation: 1987–91 and 1992–2003; ** Data for inflation and GDP:
1983–91 and 1992–2003; *** Data for inflation and GDP: 1980–91 and 1992–2001.
Source: IMF (2002, 2004)/Deutsche Bank Research (www.dbresearch.de) for data on Russia.
127
 128

Table 8.4 Emerging IT countries (full period)

Country 1980–91 1992–2003

Inflation GDP Inflation GDP

Average SD CV Average SD CV Average SD CV Average SD CV

Latin American countries

Brazil 534.25 645.22 1.21 2.76 4.30 1.56 383.00 766.89 2.00 2.46 2.09 0.85
Chile 21.78 6.82 0.31 5.06 3.00 0.59 6.86 4.28 0.62 5.44 3.64 0.67
Colombia 25.33 6.17 0.24 3.37 1.49 0.44 15.49 8.10 0.52 2.98 2.00 0.67
Mexico 61.65 39.07 0.63 2.64 3.84 1.45 15.02 10.52 0.70 2.72 3.61 1.33
Other emerging countries
Israel 111.07 118.71 1.07 3.68 1.74 0.47 7.07 4.43 0.63 3.86 2.99 0.77
Poland* 104.85 164.25 1.57 ⫺0.56 6.53 11.59 17.98 14.71 0.82 5.21 3.83 0.74
Czech Republic** 6.89 16.25 2.36 n.a. n.a. n.a. 7.61 5.61 0.74 2.24 2.18 0.97
Thailand 5.82 5.33 0.92 7.70 3.12 0.41 3.65 2.47 0.68 4.33 5.61 1.30
South Korea 8.49 8.24 0.97 7.82 3.62 0.46 4.34 1.87 0.43 5.40 4.39 0.81

Notes: SD ⫽ standard deviation; CV ⫽ coefficient of variation (SD/average) * Data from 1981; ** Data from Czechoslovakia for 1980–93.
Source: IMF (2002, 2004)/IPEADATA for Brazil’s inflation/Polish Market Review 08/2003.
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 129

had the highest output growth in recent years, and they are non-IT coun-
tries (their growth rates are 9.8 per cent, 6.1 per cent and 6.0 per cent,
respectively, in the years 1992–2003). Consequently, there is no evidence
that inflation targeting improves performance in emerging economies as
measured by the behaviour of inflation and output. This finding suggests
that better performance resulted from something other than IT.14
(b) The picture in Latin American countries should be interpreted with due
attention given that these countries have suffered currency crises recently:
Mexico in 1994–95, Brazil in 1998–99 and 2002, and Argentina in 2001–02.
Such crises have had big effects on both inflation and GDP in these
countries. Argentina, after the experience of hyperinflation (1989–90),
adopted a currency board in 1991 and the inflation rate declined sharply
during the 1990s. In 2002 the country had a serious currency crisis and,
as result, a sharp recession in 2001–02 took place, followed by a rapid
recovery after the crisis. Mexico has had poor economic performance
with a declining inflation after the 1994 Tequila crisis. Although general
conclusions are difficult to derive in the case of Latin America in view of
the fact that IT is a recent import in these countries, a general observa-
tion emerges from this experience: in three cases, Brazil, Colombia and
Mexico, economic performance worsened since the adoption of IT by
these countries (Tables 8.2–8.4). Chile is an exception. It is the single
Latin American country that has had real GDP growth above 5 per cent
on average. Non-IT countries have had similar experiences (Table 8.3).
(c) Although there is a clear downward trend in inflation in emerging coun-
tries, Brazil is an interesting case. Inflation has been maintained high in
relation to other IT countries over the relevant period; but, then, the coef-
ficient of variation is the lowest over the same period (Table 8.2).
Furthermore, Brazil’s GDP performance has been poor: the average growth
rate of GDP from 1999 to 2003 was 1.78 per cent. During the IT regime, the
interest rate has been very high in Brazil. The average nominal basic inter-
est rate (Selic) was 19.83 per cent over the period 1999 to 2004 (Figure 8.1).
The average real primary interest rate during this period was 10.2 per cent.
It was so high because monetary policy aimed at keeping inflation under
control, reducing public debt, and stabilizing the exchange rate volatility.
Indeed, empirical studies show that monetary authorities use interest rate
not only to control inflation directly but also to influence the exchange
rate, trying to control exchange rate pressures, with an evident ‘fear of
floating’.15 The consequences of high interest rates are: (i) serious con-
straint on economic growth, through the price of credit (loan rates) and
entrepreneurs’ poor expectations; and (ii) it increases public debt, which is
formed mainly by indexed bonds or short-term pre-fixed bonds.16 Despite
the significant improvement in the balance of payment figures in 2003
and 2004, Brazil’s recent experience shows that in countries with a high
level of external debt and a fully-liberalized capital account, external capital
130 Political Economy of Brazil

30.0
25.0
25.0
23.0
20.0
16.8 20.0 16.2 19.2
15.0 18.0

10.0

5.0

0.0
1999 2000 2001 2002 2003 2004 2005

Figure 8.1 Brazil: average Selic rate from 1999 to 2005

Note: Selic rate is the Central Bank of Brazil’s basic interest rate and serves as a reference for the other
rates of interest. The average Selic rate for 2005 was calculated considering the first two quarters.
Source: Central Bank of Brazil.

flows can cause periods of intense exchange rate instability.17 This can
jeopardize efforts to achieve and maintain announced inflation targets.
This situation has also caused low economic growth, because monetary
authorities tend to increase interest rates during periods of external turbu-
lence in order to meet inflation targets, and also stabilize exchange rates.
(d) In Brazil, exchange rate volatility has been considerable (Figure 8.2). As
argued earlier, macroeconomic instability brought a strong currency deval-
uation of the Real (the name of the Brazilian currency), which, as a result,
affected domestic prices via the exchange rate pass-through. This came
about through the direct impact of devaluation on the imported inputs or
indirectly through the ‘monitored’ prices. Monitored or administered
prices are defined as those that are relatively insensitive to domestic
demand and supply conditions or that are in some way regulated by a pub-
lic agency. The group includes oil by-products, telephone fees, residential
electricity, and public transportation. Its dynamics differ from those of mar-
ket prices in three ways: ‘(i) dependence on international prices in the case
of oil by-products; (ii) greater pass-through from the exchange rate;18 and
(iii) stronger backward-looking behavior’ (Minella et al., 2003, p. 7), as elec-
tricity and telephones rates are generally adjusted annually by the General
Price Index (IGP).19 Our estimation of the percentage of monitored prices to
consumer price index (IPCA) is around 28 per cent on average from April
2003 to March 2005 (Figure 8.3). Furthermore, Figure 8.4 shows that
administered prices have increased more than market prices. So that, there
is presence of an inertial component in the administered prices in Brazil as
part of them is set by contracts to the past variation of the price index.
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 131

1
0.9
0.8
0.7
0.6
0.5
0.4
0.3
0.2
0.1
0
19 01
19 05
20 09
20 01
20 05
20 09
20 01
20 05
20 09
20 01
20 05
20 09
20 01
20 05
20 09
20 01
20 05
09
99
99
99
00
00
00
01
01
01
02
02
02
03
03
03
04
04
04
19

Figure 8.2 Brazil: exchange rate volatility

Note: Exchange rate volatility is calculated using a GARCH (Generalized Autoregressive Conditional
Heteroskedastic) model, a non-linear model that is used to calculate the volatility of time series.
Source: Authors’ calculations based on data from the Central Bank of Brazil.

29

28

27

26

25
04

05
03

04
3

4
03

04
03

04
03

04
r0

r0
ry

ry
er

er
ne

ne
st

st
ril

ril
be

be
ua

ua
ob

ob
gu

gu
Ap

Ap
Ju

Ju
em

em
br

br
ct

ct
Au

Au
Fe

Fe
O

O
ec

ec
D

Figure 8.3 Brazil: percentage of administered prices over consumer price index (IPCA)
Note: Administered prices include: utilities services (fixed telephone fees, residential electricity
etc.), oil by-products, private health plans, i.e. prices that are or determined (or authorized)
directly by government (oil, private health plans) or are governmental permissions that include
some sort of price indexation. See note 7 for details on IPCA.
Source: Authors’ calculations based on data from IBGE (www.ibge.gov.br).

(e) A final comment on the transmission channel from exchange rate to

inflation in Brazil, is in order. Exchange rate variations affect the General
Price Index (IGP), which in its turn affects the index of administered
prices. As administered prices change,20 consumer price index (IPCA) is
also affected. IPCA is also affected directly by exchange rate changes due
to their effects on the imported inputs. Since IGP has been higher than
132 Political Economy of Brazil

25

20

15
(%)

10

0
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
05 2
03
20 9 1
20 0 0
20 0 0
20 0 0
20 0 1
20 1 0
20 1 0
20 1 0
20 1 1
20 2 0
20 2 0
20 2 0
20 2 1
20 3 0
20 3 0
20 3 0
20 3 1
20 4 0
20 4 0
20 4 0
20 4 1
9
19

Figure 8.4 Brazil: administered and market prices in extensive consumer price index
(IPCA)
Notes: market prices administered prices IPCA For the definition of administered
prices see note in Figure 8.3.
Source: IPEADATA (www.ipeadata.gov.br).

35 1.5
30
1.0
25
20 0.5
(%)

15 0.0
10
−0.5
5
0 −1.0
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
0 2
0 3
0 6
0 9
05 2
03
20 9 1
20 0 0
20 0 0
20 0 0
20 0 1
20 1 0
20 1 0
20 1 0
20 1 1
20 2 0
20 2 0
20 2 0
20 2 1
20 3 0
20 3 0
20 3 0
20 3 1
20 4 0
20 4 0
20 4 0
20 4 1
9
19

Figure 8.5 Brazil: exchange rate deviation and prices indexes

Note: IPCA IGP Exchange rate deviation See note 7 for details on IPCA, and note
19 for relevant details on IGP. Exchange rate deviation was calculated as the difference between
the nominal exchange rate and its linear trend.
Source: IPEADATA (www.ipeadata.gov.br).

IPCA, the latter has been influenced by the IGP behaviour through admin-
istered price adjustments (Figure 8.5).21 On the other hand, periods of
appreciation of the exchange rate, with some lag, have resulted in a
decrease in the rate of inflation, after a time lag. So, inflation in Brazil is
very much influenced by exchange rate movements.22 Under these condi-
tions, monetary policy may have some effect on market-determined prices,
but it is not very effective in controlling administered prices. Consequently,
in view of the importance of administered prices in the determination of
the Brazilian inflation rate, inflation pressures result in the Central Bank
of Brazil having to increase interest rates higher than might be necessary
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 133

to restrain inflation that derives from market prices. This is so since the
Central Bank has to account for the secondary effects that emanate from
the shocks of monitored prices.23 This more aggressive monetary policy
generates negative effects on income and employment.

6 Summary and conclusions

We have summarized the theoretical aspects of IT, and the principles that
govern its implementation in the case of Brazil. It is clear from this analysis

(a) Latin American IT countries

Brazil 1995–2003 Chile 1981–2003

35
25
30
20
25
15 20
10 15
10
5
5
0 0
1995 1996 1997 1998 1999 2000 2001 2002 2003 1981198319851987198919911993199519971999 20012003

Colombia 1989–2003 Mexico 1989–2003

35 40
30 35
25 30
25
20
20
15 15
10 10
5 5
0 0
19 9
19 0
19 1
19 2
19 3
19 4
19 5
19 6
19 7
19 8
20 9
20 0
20 1
20 2
03

19 9
90

19 1
19 2
19 3
19 4
95

19 6
19 7
19 8
20 9
00

20 1
20 2
03
8
9
9
9
9
9
9
9
9
9
9
0
0
0

9
9
9
9

9
9
9
9

0
0
19

19

19

19

20

(b) Latin American non-IT countries

Argentina 1992–2003 Uruguay 1992–2003

45 80
40 70
35 60
30 50
25 40
20
15 30
10 20
5 10
0 0
-5
92

93

94

95

96

97

98

99

00

01

02

03
19

19

19

19

19

19

19

19

20

20

20

20
92

93

94

95

96

97

98

99

00

01

02

03
19

19

19

19

19

19

19

19

20

20

20

20

Venezuela 1992–2003
120
100
80
60
40
20
0
92

93

94

95

96

97

98

99

00

01

02

03
19

19

19

19

19

19

19

19

20

20

20

20

Figure 8.6 Latin American IT/non-IT countries

Sources: IMF (2002, 2004); IPEADATA for Brazil.
134 Political Economy of Brazil

Czech Republic 1994–2003 Israel 1986–2003

12 60
10 50
8 40
6 30
4 20

2 10
0
0

1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003

Poland 1992–2003
South Korea 1988–2003
50
45 10
40 9
35 8
30 7
6
25
5
20
4
15 3
10 2
5 1
0 0
1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

19 8
19 9
19 0
19 1
19 2
19 3
19 4
19 5
19 6
19 7
19 8
20 9
20 0
20 1
20 2
03
8
8
9
9
9
9
9
9
9
9
9
9
0
0
0
19

Thailand 1990–2003
9
8
7
6
5
4
3
2
1
0
90
91
92
93
94
95
96
97
98
99
00
01
02
03
19
19
19
19
19
19
19
19
19
19
20
20
20
20

Figure 8.7 Other emerging non-Latin American IT countries

Source: IMF (2002, 2004).

that the authorities in Brazil adhere religiously to the theoretical principles

of the IT framework. We have examined the experience of Brazil with IT,
compared it with the experience of the pre-IT period and with the experi-
ence of other countries, IT and non-IT ones.
Two general conclusions emerge from this analysis. IT countries appear to
have been successful in taming inflation. But, then, so have non-IT coun-
tries. Furthermore, although Brazil has implemented IT as the theory of the
framework suggests, inflation rates over the IT period have been high. Brazil
has one of the highest interest rates in the world, along with inflation, which
has been maintained at a significantly high level. The Central Bank of Brazil has
to maintain very high interest rates in its attempt to control inflation. High
interest rates have caused poor economic growth performance, and deterio-
ration of other macroeconomic variables, such as public debt. It appears that
we have a rather bad economic scenario in Brazil: low economic growth with
relatively high inflation.
Our results conform to recent contributions on the IT experience of a
number of Latin American countries. Especially so with Eichengreen’s (2002)
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 135

China 1992–2003 Egypt 1992–2003

30 18
25 16
14
20 12
15 10
8
10 6
5 4
2
0 0
−5

92

93

94

95

96

97

98

99

00

01

02

03
19

19

19

19

19

19

19

19

20

20

20

20
92

93

94

95

96

97

98

99

00

01

02

03
19

19

19

19

19

19

19

19

20

20

20

20
India 1992–2003 Malaysia 1992–2003
14 6
12 5
10 4
8
3
6
4 2
2 1
0 0
92

93

94

95

96

97

98

99

00

01

02

03

92

93

94

95

96

97

98

99

00

01

02

03
19

19

19

19

19

19

19

19

20

20

20

20

19

19

19

19

19

19

19

19

20

20

20

20
Russia 1996–2003 South Africa 1992–2001
100 16
90 14
80
70 12
60 10
50 8
40 6
30
4
20
10 2
0 0
1996 1997 1998 1999 2000 2001 2002 2003 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001

Turkey 1992–2003
120
100
80
60
40
20
0
92

93

94

95

96

97

98

99

00

01

02

03
19

19

19

19

19

19

19

19

20

20

20

20

Figure 8.8 Emerging non-IT countries

Source: IMF (2002, 2004).

contention that IT is more complicated in countries like the Latin American

ones, essentially for three main reasons: their economies are exposed to
financial and international commodity shocks because of the liberalization
of the balance of payments trade, financial and capital accounts; their liabil-
ities are almost dollarized; and their policymakers lack credibility. The first and
the second reasons are particularly pertinent in the case of Latin America
countries. Openness exposes these economies to disturbances that emanate
from exchange rate fluctuations that cause pass-through inflation. Liability dol-
larization affects financial institutions because, in general terms, the bank-
ing system of Latin America countries is weak, and as such it brings financial
vulnerability when external shocks occur. However, Paula and Alves Jr. (2003)
demonstrate that this is not typical of the Brazilian banking sector in recent
136 Political Economy of Brazil

years. Moreover, IT is too rigid for these countries essentially because it affects
economic growth and exchange rate flexibility that is required under such a
regime of monetary rules. The latter can cause financial instability, a very real
possibility in these countries as history has demonstrated vividly. Schmidt-
Hebel and Werner (2002) are very clear on the dangers of IT: ‘all Latin
American inflation targeters are open economies that employ floating exchange
rate regimes . . . [and] are subject to large external shocks and significant
exchange rate volatility, and the exchange rate may therefore play an import-
ant role in the conduct of monetary policy under inflation targeting’ (p. 2).
Exchange rate market volatility generates frequent changes to inflation rates
and results in countries not being able to meet their inflation targets.
The larger external shocks faced by Latin America countries affect the
exchange rate, and, consequently, the inflation rate, leading to higher interest
rates to curb the inflationary pressures. As a result, these economies in gen-
eral are confronted by higher volatility of interest rates and exchange rates.
In this context, ‘monetary policy in emerging economies may therefore be
more sensitive to exchange rate movements both indirectly (because of pass-
through effects on inflation) and directly (because the exchange rate is an
additional argument in central bank objective functions, reflecting their
concern for devaluation-induced bank failures and domestic recessions)’
(Schmidt-Hebel and Werner, 2002, p. 15). In other words, the pass-through
from exchange rate changes to inflation is larger and more significant in the
Latin American economies than in industrial countries because the former
have a substantially higher degree of openness, a history of high inflation,
and low central bank credibility. In addition, Latin American countries pre-
sent large mismatches between foreign currency assets and liabilities, which
bring two adverse shocks: self-fulfilling attacks and financial crises on the
country’s assets and domestic recession following large exchange rate depre-
ciations. It is the case that Latin American countries are susceptible to supply
shocks, perhaps more so than many other countries, than to demand shocks.
To the extent that this is validated, IT might not work as effectively as in
those countries where demand shocks dominate over supply shocks.

Notes
* We are very grateful to Fabio Barcelos for generous research support in the form of
collecting data on developing and emerging countries, especially on Brazil, and for
producing the tables and figures for the chapter. We are also grateful to Lilian
Furquim for providing data relevant to Figure 8.5.
1 Arestis and Sawyer (2005) provide an extensive discussion of the IT theoretical
framework.
2 The Brazilian Real Plan differed from Argentina’s Convertibility Plan in that it
adopted a more flexible exchange rate anchor. At the launch of the Brazilian pro-
gramme in July 1994, the government’s commitment was to maintain an exchange
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 137

rate ceiling of one-to-one parity with the dollar. Moreover, the relationship between
changes in the monetary base and foreign reserve movements was not explicitly
stated, allowing some discretionary leeway. After the Mexican crisis, the exchange
rate policy was reviewed and in the context of a crawling exchange rate range, the
nominal rate began to undergo gradual devaluation. In early 1999, however, after
six months of speculative pressure, the real was devalued and, some days later, the
Brazilian government adopted a floating exchange rate. For a general analysis of
the origins and development of the Real Plan, see Ferrari, Filho and Paula (2003).
3 During the pegged exchange rate period, July 1994 to January 1999, the basic
interest rate (Selic) was raised and kept at high levels in order to avoid large out-
flow of reserves.
4 CMN has three members: the Minister of Finance, the Minister of Planning and
the Governor of the Central Bank of Brazil. Besides the inflation target, CMN is
also responsible for the approval of the main norms related to monetary and
exchange rate policy, and to the regulation of the financial system.
5 COPOM was created on 20 June 1996, and was assigned the responsibility of set-
ting the stance of monetary policy and the short-term interest rate. It is composed
of the members of the Central Bank of Brazil’s Board of Directors.
6 IPCA covers a sample of families with a multiple of up to 40 times the minimum
wage, which is determined every year by the Brazilian federal government. It now
stands at approximately US$ 130 per month, and it is thought to be enough to
cover the basic needs of a family. The sample covered by IPCA has a broad geo-
graphical basis that includes families in the biggest cities of Brazil. IPCA is calcu-
lated by IBGE (National Bureau of Geography and Statistics).
7 For more information on the macroeconomic background that led to the shift of
IT in Brazil, see Bogdanski et al. (2000).
8 Minella et al. (2003) calculations are based on the structural model of the Central
Bank of Brazil and the information concerning the mechanisms for the adjust-
ment of administered prices.
9 At the beginning of 2003 the new federal government announced a change in the
inflation targets for 2003 and 2004. They were raised to 6 per cent and 5.5 per cent
for 2003 and 2004, from the original inflation targets of 4.0 per cent and 3.25
per cent, respectively.
10 For most countries that do not adopt IT we use data from 1992 to 2003. Since
South Africa adopted IT very recently (2002), we have included this country in the
group of non-IT, but using data only until 2001.
11 The reason for excluding periods of high inflation is that during those periods the
rate of inflation is so high and after the price stabilization (in general with some
sort of exchange rate anchor) the rate of inflation is so low (compared with the
former period), that the shift produces a huge distortion in the time series of infla-
tion figures. This would complicate the comparison between the period before IT
and after IT in Table 8.2. For Table 8.3 and Table 8.4, however, we have not
excluded any data, unless they were not available.
12 Once more we have excluded periods of high inflation in Figures 8.6–8.8 as the
inclusion of these periods would cause an enormous distortion in the figures.
13 Note that in our sample (Tables 8.2–8.4), Venezuela is the single exception, as aver-
age inflation increased from 1980–91 (35.4 per cent) to 1992–2003 (40.2 per cent),
although since 1996 the inflation rate in this country has traced a downward trend.
14 One might argue that these findings are due to specific economic problems of
emerging countries, in a way that developed countries are not faced with, and
138 Political Economy of Brazil

thus IT might be better suited for these countries. However, a recent paper on
OECD countries shows that this is not the case: comparing seven OECD countries
that adopted inflation targeting in the early 1990s to 13 that did not, Ball and
Sheridan (2003) find that on average there is no evidence that IT improves per-
formance as measured by the behaviour of inflation, output, and interest rates.
They conclude that ‘the formal and institutional aspects of targeting – the public
announcements of targets, the inflation reports, the enhanced independence of
central banks – are not important. Nothing in the data suggests that convert targets
would benefit from adopting explicit targets’ (p. 29, italics added; see also Arestis and
Sawyer, 2005).
15 Mendonça (2005), using a Taylor rule to study the determination of interest rate
by the Central Bank of Brazil, over the period 1999–2004, finds that exchange rate
changes explained a great deal of the variation of the Selic interest rate (around 57
per cent after one year of the exchange rate shock in 2003).
16 The behaviour of the domestic public debt in Brazil has proved particularly vul-
nerable to changes in the rate of interest and exchange rate (see, in this regard,
Paula and Alves Jr., 2003).
17 According to data from Central Bank of Brazil, the ratio of external debt to exports
declined from 3.6 in 2001 to 2.1 in 2004, due to the recent increase in exports,
and the ratio of foreign reserves to external debt increased from 17.1 in 2001 to
26.3 in 2004. Although there is a significant improvement recently in the exter-
nal vulnerability indicators, they are still in the range of what is considered ‘dan-
ger’ for the country.
18 According to Minella et al. (2003) ‘[t]here are three basic links (i) the price of oil by-
products for consumption depends on international oil prices denominated in
domestic currency; (ii) part of the resetting of electricity rates is linked to changes in
the exchange rate; and (iii) the contracts for price adjustments for electricity and tele-
phone rates link these adjustments, at least partially, to the General Price Index (IGP),
which is more affected by the exchange rate than the consumer price indexes’ (p. 7).
19 IGP is prepared by Getulio Vargas Foundation, a private foundation, and it is cal-
culated through a weighted index that includes wholesale price index (60.0 per
cent), consumer price index (30.0 per cent) and national index of building costs
(10.0 per cent). The reason for the use of this index to adjust electricity and tele-
phones rates (instead of IPCA) is that when these services were privatized in the
second half of the 1990s, Brazilian government was interested in attracting for-
eign firms, and for these firms IGP is better than IPCA, as it is much more sensitive
to exchange rate variations (due to the high weight of the wholesale price on it).
20 Minella et al. (2003, p. 25) estimated that the pass-through to administered prices
from July 1997 until December 2002 was 25 per cent, resulting in a pass-through
of about 16 per cent for the headline IPCA.
21 Figueiredo and Ferreira (2002), using a simple regression, identify the general
index of prices and the index of domestic supply prices as the main components
that explain the difference between movements in markets prices and adminis-
tered prices.
22 Ferreira (2004), using a VAR model to evaluate the determinants of the rate of
inflation in Brazil in 1995–2004, finds a positive response of inflation to shocks in
nominal exchange rate, an effect that spreads over time. In the same connection,
Gomes and Aidar (2005) estimate, using a VAR, a Taylor rule for the Brazilian
economy from January 1999 to May 2004, and conclude that 24.4 per cent of the
inflation rate (IPCA) variation is explained by the exchange rate. It is interesting
 Philip Arestis, Luiz Fernando de Paula and Fernando Ferrari-Filho 139

that some economists of the Central Bank of Brazil also conclude that ‘exchange
rate volatility is an important source of inflation variability. The design of the
inflation-targeting framework has to take into account this issue to avoid that a
possible non-fulfilment of inflation targets as a result of exchange rate volatility
may reduce the credibility of the central bank’ (Minella et al., 2003, p. 29).
23 The credit channel is also limited in Brazil since the ratio of credit to GDP has
been around 24–30 per cent in 2000–04, according to data from Central Bank of
Brazil, while it was 45.3 per cent in US, 84.7 per cent in Japan and 103.7 per cent
in the euro area in 2000 (Belaisch, 2003).

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