II. Inflation

Despite all the difficulties cited above, the Real stabilization program implemented in July 1994 generated a climate of euphoria and exaggerated optimism that carried over into the initial months of the Cardoso government. Several factors explain this phenomenon.

The inflationary trend has been extremely positive since the introduction of the real. Inflation during the first twelve months of the Real Plan was, according to the consumer price index, 35.3%. In the first six months of this year, the accumulated inflation was approximately 10%. This percentage equaled the inflation Brazil accumulated in the first six or seven days of June 1994. The fall in the inflation rate is even more impressive if one takes into consideration that, contrary to prior stabilization plans, the Real Plan did not freeze or prefix prices.

The success of the Real Plan's fight agaisnst inflation becomes obvious when one considers earlier tabilization programs. Table I traces the evolution of the consumer price index immediately following implementation of five stabilization plans, showing the average monthly rate in each quarter. The Real Plan shows the lowest average inflation during the first year. Moreover, under earlier plans, inflation began to rise strongly in the second quarter of the program, with average inflation exceeding 10% per month in the fourth quarter (remember that data for the fourth quarter of the Collor Plan I already incorporated the measures introduced by Collor Plan II).

 

Table 1

Consumer Price Index (IPC/FIPE), Post-Stabilization Plans
(monthly average)

	Cruzado	Bresser	Verão	Collor I	Real
Beginning	March 1986	July 1987	January 1989	April 1990	July 1994
1st-3rd month	2.02%	6.81%	10.16%	13.47%	3.24%
4th-6th month	1.30%	13.16%	23.31%	12.09%	2.48%
7th-9th month	2.98%	15.58%	34.69%	16.81%	1.35%
10th-12th month	11.78%	21.10%	56.44%	16.35%	2.42%
1st year average	4.44%	19.11%	30.07%	14.66%	2.36%

Graph 1 shows the month to month evolution of the consumer price index (IPC/Fipe) immediately after the initiation of the five stabilization plans mentioned above. The Summer Plan witnessed inflation of more than 30% per month after its seventh month of existence.

Graph 1 - Consumer Price Index (IPC/FIPE), Post-Stabilization Plans (monthly %)

Even though Brazil's present double-digit annual inflation is high by international standards, the following points should be highlighted:

• Average inflation fell from 43% per month in the first half of 1994 to 2.55% (IPC-R) per month in the first year of the Real Plan. If one discounts the inflation of the first two months of the Real Plan, which was a transition period (the carryover effect), the average inflation of the Plan has been 1.92% per month.

• Wholesale prices undergo less variation than do consumer prices. This difference indicates that a substantial part of the inflation during the first year of the Real Plan stemmed from price increases for non-traded goods. After one year of the Plan, prices of services may now start to decline, permitting smaller fluctuations in retail prices.

• Despite the existence of salary indexation, which tended to transform a seasonal rise in prices into a permanent increase, the variations in the price indices indicate a partial breakdown of the indexation mechanism. Graph 2 shows the rise and fall in monthly price indices, suggesting a behavior similar to that observed in countries without indexation.

Graph 2 - Monthly Inflation [General Price Index (IGP-M) and Consumer Price Index (IPC-R)]

• The cost of the basic food basket declined from R$106.95 at the beginning of the Real Plan to R$101.88 on August 28, 1995. Considering that minimum salaries during this period rose 42%, the purchasing power of workers obviously improved.

Although the redistribution of income may not have been a priority objective of the stabilization plan, the fall in inflation during the first year of the real was accompanied by substantial income redistribution. After all, a substantial part of the inflation tax had been falling on the lowest income sector that had no way to protect itself against inflationary affects.