Class 3 & 4

Question 1

What should the objectives of an economic policy be? (7)

Answer 1

1. Promote GDP growth
2. Reduce the unemployment rate
3. Keep inflation under control
4. Seek external balance
5. Seek fiscal balance
6. Provide a business environment so that companies would be competitive
7. Improve the population’s standard of living

Question 2

Which microeconomic prices need to be in the right place and be monitored by the government, and even intervened if necessary? (5)

Answer 2

1. Interest rate (it cannot be so high that it prevents the entrepreneur from investing in his own business)
2. Exchange rate (it must encourage local companies to export but it cannot be so devalued that it hinders strategic imports)
3. Wages rate (it must give workers purchasing power)
4. Inflation rate (it must be zero or as low as possible)
5. Profit rate (it is the most important because there is no capitalism without profit)

Question 3

What are the objectives that governments should pay attention to? (5)

Answer 3

1. The issue of fiscal imbalances (predominantly macroeconomic issues).
2. The issue of low productivity (predominantly microeconomic issues)
3. The issue of inequality (a political issue that affects the entire economy)
4. The issue of foreign trade (macro and microeconomic)
5. The issue of inflation (mostly macroeconomic)

Question 4

What are the tools to accomplish the 5 objectives? (2+5+2)

Answer 4

1. Fiscal Policy - refers to public sector expenditures and revenues.

• Primary and nominal (or Budget Balance) deficit
• SELIC = the reference interest rate in Brazil defined by Central Bank

2. Monetary Policy - refers to issuing currency, establishing interest rates and controlling inflation.

• Reassure control of the currency and economy (ex: hyperinflation and the rush to buy dollars → weakens Real)
• Inflation: not only because of excess of demand but also (especially when unemployment is high) bc of the price of the dollar, fear of instability, and price increases in sectors where there is a lack of supply

3. Exchange Rate Policy - refers to determining the exchange rate and stimulating exports

• Strengthening of Real: in 1994 the currency was artificially strong, to facilitate imports and keep domestic prices low (overvalued, so the products abroad seem cheaper because the currency is strong)
• When Real is devalued, the imports are more expensive and the final price will also increase, which means it will be harder to sell the final product → many Brazilians factories closed because of this

Question 5

When there’s high inflation, what does the government usually do? Is it good or bad, and why? (4 steps)

Answer 5

Usually, when there’s high inflation, the government increase interest rates, but that’s bad because:

• It attracts foreign capital that currently has few options around the world and comes to Brazil, attracted by the high rate.
• As a result, the real strengthens.
  It becomes harder to export and easier to import.
• It further cools down the economy because if a businessman was going to invest in his own company, he would prefer to invest in Treasury bonds
• To pay the debts, the gov need to attract capital, so it pays a high interest rate, and there’s the cycle

Question 6

What affects the Exchange rate in Brazil? (1+3+2)

Answer 6

1. Society’s expectations regarding the government’s ability to solve problems.
2. The current account balance managed by the Central Bank

• Trade Balance (= Exports - Imports)
• Income (income from investments, like dividends, interest, and profits earned abroad - foreign payments)
• Transfers (foreign aid, remittances from expatriates, and pensions received from abroad, - payments sent abroad)

3. When a country has a current account deficit (= imports or pays more than exports or earns), governments usually are forced to devalue the currency (makes the country’s exports cheaper and more competitive in international markets, which encourages exports and discourage imports, that become more expensive in local currency).

• (Bonus, not in the slides: however, that increases inflation, foreign debt burden and erosion of confidence)

Question 7

What’s Brazil main export product? And what’s the problem in being overly dependent on it? (2)

Answer 7

Commodities

• Commodities’ prices fluctuate depending on the balance between supply and demand for each one on international exchanges
• Dutch disease: exporting commodities = attracts more dollars = strengthen Real → harder to export manufactured products but easier to import them → problem for the local manufacturing industry
• Doesn’t have much aggregated value in it “No nation can survive with dignity exporting only their agricultural commodities and minerals, to pay, for example, for the importation of pharmaceuticals or computers, as is the rule today in almost all Latin American countries”.