Macroeconomic Principles – The Real Plan

Macroeconomic Principles – The Real Plan

In the early 1990s, Brazil showed a terrible economic scenario. Inflation was not below 100% a year since 1982 and it peaked at 2.477% in 1993. To combat the inflation, on July 1, 1994, Brazil implemented the last, and until now, most successful of its economic stabilization programs to end inflation: the Real Plan. The Real Plan came after a series of economic plans that proved ineffective and that led to rising inflation, supply crisis in the markets, layoffs, among other consequences, even the goal being just the opposite. In common, these plans, launched between the governments of presidents José Sarney (1985-1990) and Fernando Collor de Mello (1990-1992), betted on the freezing of prices and wages.

Together with the combat to inflation, the Real plan also had the intention to consolidate prices, to demand the production and to create more jobs, thereby generating income to strengthen the purchasing power and consequently stabilize the economy. To this end, the Real Plan was related to some key factors: finish with the public deficit, de-index the economy, re-index the economy according to the nominal exchange rate, open economy by reducing import tariffs and increase sharply international reserves.

The Real plan was architected by the economic team created by Fernando Henrique Cardoso, then finance minister of Itamar Franco's government. Since the beginning, the Real Plan faced resistance, especially because of the distrust in a new economic plan because of the failure of previous plans. Besides that, the challenge was even bigger because it involved not popular policies as cutting government's spending, forecast of tax increases and the possibility of loss in a part of the wages with the creation of the new currency.

All major political parties rejected the 5% increase in federal taxes and the creation of the Social Emergency Fund, both measures related to Real Plan. One of the political parties, "Partido dos Trabalhadores", was one of the main oppositions to the program. Luiz Inacio Lula da Silva, the future president of Brazil, criticized the Real Plan indicating possible electoral interests in the measures taken. Unions also rejected the tax increase. Until even inside the PSDB, presidential political party at the time, there were people who showed divergence about the plan. Only after more than two months, the real plan was approved by the parliament.

To avoid freezing prices and rising inflation, as happened in previous attempts, the economists decided that the plan would be implemented in three stages. The first step was the adjustment of public accounts through a cut in the budget. In August 1993, the finance minister announced the cut of three zeros in the currency, the “Cruzeiro”, and announced the launch of a new currency, the “Cruzeiro Real”.

        The second stage would be the implementation of the Real Value Unit (URV), a virtual currency to de-index the economy and to be an alternative to the price freeze. It was in force from March to July 1994 and was a kind of bargaining chip, used to convert the values of commodities. It was protected from inflation because it was linked to the nominal exchange rate. In practice, all prices were rescheduled with values in URV, which was linked to the dollar. The currency that effectively circled was the "Cruzeiro Real" and every day was released the equivalent value of the URV in "Cruzeiro Real". Little by little, the economy has become accustomed to stable prices. The role of the URV was to promote the "dollarization" of the economy without it being necessary to renounce the national currency.