Brazilian public sector disequilibrium

Abstract

The Brazilian public sector disequilibrium, as measured by growth in the global net public sector debt to GDP ratio, is examined with and without the Plano Cruzado. Two models are used, one based upon a discrete time framework and the other upon a continuous time framework, to trace paths of the debt to GDP ratio for the rest of the decade concentrating on the 1985–1986 period. Two major conclusions are reached. The first, of a theoretical nature, is that discrete time models are inappropriate in an inflationary context as they severely underestimate the inflation tax. This is evidenced by the fact that without the Plano Cruzado and an assumed inflation rate of 350%, the debt to GDP ratio grows from 1985 to 1986 in the discrete time model while it declines for this period in the continuous time model. The second is that the Plano Cruzado may put strong pressure on government finances in the near future due to the drastic fall in the inflation tax. In this case, both models show an acceleration in the growth of the debt to GDP ratio, the more drastic results appearing in the continuous model. This conclusion seems to hold true even if one allows the government to trade debt for monetary base with the consequent increase in money demand due to lower inflation, to roll over its internal debt at a lower average interest rate, or to roll over its foreign debt outstanding at a lower average interest rate.