“If economists ruled the world, there would be no need for a World Trade Organization. The economist’s case for free trade is essentially a unilateral case: a country serves its own interests by pursuing free trade regardless of what other countries may do.
-Paul Krugman, Nobel Laureate
The Summer Olympics just opened in Rio de Janiero this week in the midst of the country’s severe recession and deep political crisis. Brazil has dealt with a high inflation rate, a fiscal deficit, and a political crisis that has evolved from a corruption crisis at the state-controlled oil company Petrobras. The President of Brazil, Dilma Rousseff, is being indicted on charges of breaking budget laws and is facing an impeachment trial that is expected to oust her from office. After a long history of deficits which led to credit defaults and currency crises in the past, Brazil has made great improvements and its implementation of hard-budget constraint legislation-the Fiscal Responsibility Law- which was applicable to all levels of government regardless of their prior economic conditions. Unfortunately, the impeachment of the Brazilian president relates to her allegedly using irregular accounting maneuvers to disguise the size of the budget deficit.
Their situation is extremely serious. Output is contracting; fiscal revenues are faltering; and the budget deficit exceeds 9% of GDP. Inflation has surpassed the double-digit mark, forcing the central bank to raise interest rates – an approach that is unsustainable, given the deepening recession and the ballooning cost of servicing Brazil’s rapidly growing debt. The situation is still deteriorating, owing partly to China’s economic slowdown, the end of the commodity boom, tighter international financial conditions, weak global growth, and a years-long legacy of policy mismanagement. Without market credibility, interest rates and credit spreads will remain high and hijack the fiscal-adjustment effort, forcing the economy into a downward spiral. Moreover, budgetary pressures will make it increasingly difficult for the central bank to raise short-term interest rates to fulfill its mandate of curbing excess inflation. In short, Brazil lacks fiscal and monetary credibility