Monetary Statecraft in Brazil

Kurt Mettenheim

• Publisher: Routledge
• Year: 2015
• ISBN:
  9781317339403
• Edition: 1
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

Brazil has one of the world's fastest growing economies and a fascinating history underpinning its evolution. This book presents an analysis of the state's role in monetary policy, from the latter days of Portuguese rule, to the present day. Based on a variety of unknown archival sources, this study offers an alternative explanation for the rise and fall of Brazilian currencies.

Monetary statecraft is a theory that accounts for the open ended, autonomous character of politics, the complex, recursive phases of public policy, and political development in the traditional sense of social inclusion. Unfortunately, there are few precedents for this type of analysis. This book fills this gap by tracing how Brazilian policy makers and observers have sought, experimented with, and reflected on a variety of forms and solutions for monetary policy since 1808.

This book will be of interest to economists, financial historians and those interested in the history and economy of Brazil.

1
Introduction

From the economics of politics to the politics of monetary policy

[W]hile institutions respond to supply and demand or to economic necessity, as the Coase theorem asserts, they do so within a social and political structure that profoundly shapes the outcomes. Supply and demand propose … the social matrix disposes …

—Charles Kindleberger, A Financial History of Western Europe, p. 410

Monetary statecraft is a theory that accounts for the open-ended, autonomous character of politics, the complex, recursive phases of public policy, and political development in the traditional sense of social inclusion. Unfortunately, there are few precedents for this type of analysis. Since the testimony of US Treasury Secretary Douglas to Congress in 1941,¹ or the overview of finance in Western Europe by Ardant in 1975,² we were unable to find a compelling framework for analysis of monetary policy and political development that averts fallacies about central bank independence in economics or overemphasis on policy capture in sociology. Moreover, Ardant warned that European experiences do not apply to developing countries because ‘numerous bottlenecks intervene between demand and any response of agriculture or industry’, and therefore, ‘solutions must be sought in different forms’.³ This book traces how Brazilian policy makers and observers have sought, experimented with, and reflected on precisely such different forms and solutions for monetary policy since 1808.

Explaining how monetary phenomena constrain and enable government and political development proved easier said than done. This book began as an account of how gradual, muddling through policy making in 1994 ended inertial inflation and paved the way for modernizing monetary authority in Brazil.⁴ These techniques of monetary statecraft (rather than heterodox shocks or big-bang reforms then in vogue) helped reverse the legacies of both mismanagement under military rule and capture by oligarchs that had delayed democracy and deepened monetary chaos. However, the seemingly endless series of currency crises faced by Brazil and other emerging economies (Mexico, 1994–1995; Asia, 1997; Russia, 1998; Brazil, 1999; Argentina and Turkey, 2001; Brazil 2002–2003) made it difficult to disentangle politics from markets, markets from policies and the pains of adjustment from advances produced by reforms. A historical approach provided relief in the form of distance and, more importantly, an analytic advantage by increasing the number of cases to elaborate concepts and theories about monetary statecraft.

Reconstructing the politics of monetary policy since the Portuguese crown arrived in Rio de Janeiro in 1808 extends and reinforces the central thesis of this book: that advances of central banking and monetary policy in Brazil since the mid-1990s (notwithstanding remaining obstacles to growth, democracy and social inclusion) were achieved by muddling through and adapting ideas from abroad to the particularities of underdevelopment in Brazil. We found this to be true of politics and monetary policy in previous periods of Brazilian history and submit that it reveals much about political economy in developing countries. Theories of domestic statecraft in comparative political economy uniquely explain how monetary policy makers in Brazil muddled through, reacted to circumstances and sought to balance political imperatives and market confidence by adapting theories and policy frameworks from abroad.

The chapters of this book use largely untapped primary materials and secondary accounts to trace the politics of monetary policy: during monarchy, independence and empire (1808–1889); a republic controlled by oligarchs and single-state parties (1889–1930); national populism and import substitution industrialization (1930–1945); post-war democracy wracked by disputes between developmentalists and monetarists (1945–1964); military rule that first imposed austerity but soon turned to state-led developmentalism (1964–1985); protracted transition and monetary chaos (1985–1994) and, finally, price stability and democratization (1994–2014). For each of these periods, historical-institutional analysis and policy process tracing⁵ reveal how politics shaped monetary policy while controlling for alternative explanations from economics and sociology. Concepts and theories about the phases of public policy help explain further how problem identification and agenda setting shape the formulation, implementation and evaluation of monetary policies: phases that often become recursive when new problems begin the policy process once again.

Tracing the politics of money across political regimes and phases of public policy confirms the conclusions of Kindleberger, Allen and Gale, and Shonfield: that political choices shape national systems of money and finance in particular, path-dependent trajectories.⁶ Statistical analyses of aggregate cross-national data have proven singularly unable to explain similarities and differences in the politics of monetary policy across countries – a typical result of excessive data aggregation that often conceals rather than reveals causes. Recent advances in case study selection and research design make it possible to skirt both these fallacies of aggregation and randomization that weaken statistical inferences about politics and monetary policy. Qualitative methods provide better tests of competing theories to leverage our causal findings about politics and monetary policy. To better control for competing explanations of politics and monetary policy, we draw causal inferences instead from in-depth case study, historical-institutional analysis, and process tracing.

The theory of monetary statecraft focuses on how the formulation and implementation of rules, policies and procedures by government agents mandate basic monetary functions and relations in society and markets.⁷ From this perspective, monetary policy makes money by providing funds for government beyond taxes and tariffs by setting value and allocating resources in state and society, and by shaping markets and monetary phenomena. Monetary statecraft requires balancing domestic political support, economic realities, and market confidence.⁸ Monetary statecraft is a specific type of economic statecraft that involves phenomena of money, prices, banking, finance, government accounts, foreign exchange and politics. Monetary statecraft, like most concepts and theories in the social sciences, cuts to essentially contested,⁹ core ideas about money, markets, government intervention, public policy and politics.

Theories of money and monetary statecraft

Because money serves as a medium of exchange, store of value, unit of account and means of payment,¹⁰ the stakes of monetary policy are high and theories are especially contested. Neo-classical approaches in economics are anti-politics; they conclude that no politics is the optimal monetary policy. In a broader sense, most sociologists and political scientists tend to agree by asserting, and often finding, that central banks and other entities responsible for monetary policy tend to be captured by banks and financial interests – the very entities that regulators should be regulating.¹¹ Deregulation in the United States and other advanced economies after 1970 did, in fact, facilitate capture of monetary policy through ‘blood sport’ lobbying, revolving door appointments, policy agenda setting and other mechanisms.¹² However, errors of deregulation in the United States should not be elevated to theory. Monetary policy is not always controlled by banks and corporate interests; this would ignore most periods of US history, other national experiences that have averted capture, and perhaps most importantly, lead us to underestimate prospects for reform. The mistakes of deregulation in the United States were expensive.¹³ However, many experiences in Brazilian history, and the modernization of central banking amidst democratization in the country since the 1990s, cannot be explained as a result of political aggrandizement (as economic theories insist) or capture by bankers (as theories from sociology assert).

Understanding the politics of monetary policy is further complicated by the fact that theories of money are also deeply contested. Quantitative theories in the neoclassical tradition of economics suggest that central bank policies are exogenous determinants of the money supply.¹⁴ Theories in the Keynesian tradition emphasize commercial banks as endogenous multipliers of money.¹⁵ In the past, the ‘currency school’ argued that money must be backed by the real value of precious metals such as gold or silver. In opposition, the ‘banking school’ argued that the value of money was not determined by reference to the value of precious metals. Instead, money was a commodity, much like any other, and therefore subject to forces of supply and demand. The value of paper notes issued by commercial banks therefore extrapolated from fixed metallic references, because of market forces and the reality that bank credit multiplies money (albeit limited by fractional values of metallic reserves).

Disputes about the nature of money pervade the history of political economy.¹⁶ For much of the 20th century, debates turned on differences between Keynesians and monetarists. The spectre of hyperinflation and debates about currency reforms in the 1920s gradually ceded, after 1945, under Bretton Woods arrangements that helped sustain several decades of more stable money, prices, and foreign exchange rates in advanced economies. However, once the US dollar was taken off a fixed exchange rate for gold in 1971, foreign exchange volatility and increasing uncertainty returned to produce reassessment of politics and monetary policies. The globalization of money markets, monetary unification in Europe, devastating currency crises across emerging and developing countries and the global financial crisis of 2007–2008 have placed money and monetary policy once again at the centre of research agendas in political economy, public policy and regulation.

Unlike most studies that focus on top global currencies, this book examines the politics of monetary policy in Brazil, a country traditionally lower in typologies of international currencies. The Brazilian case reveals both how monetary policies reinforced underdevelopment in the past and helped bring the country out of underdevelopment. A broader view of deeply contested theories about politics, money and monetary policy is required to explain this trajectory. Scholars and policy makers disagree, fundamentally, about whether money is, and should be, a private matter of free market exchange or, instead, that management of money is essential for state sovereignty and capacity. For most economists, money remains secondary to broader forces in the real economy unless it ‘gets out of order’. And for most economists, politics and government policies are the prime suspects when inflation surges or money is devalued (or overvalued). Modern monetary theory argues that monetary phenomena are far more important in shaping real economic activity, but agree that politics and governments, almost inevitably, distort money and prices to produce bad equilibrium.

Chartalist theories of money provide an alternative explanation of how money is shaped by state policies such as the power to tax and the valuation and circulation of fiat money by force of law.¹⁷ The origin and evolution of national currencies are inexorably related to the fiscal authority of governments. Modern national currencies arose with nation states and remain central to state sovereignty and policy making.¹⁸ This differs fundamentally from neo-classical explanations of the origin of money in private transactions. For Chartalist theory, modern money arose from state mandates that payments (especially taxes) be paid in official currency. Char-talist theories of money help explain the origin and evolution of money in Brazil and clarify causal relations between politics and monetary policy.

State theories of money have suffered from association with Knapp, especially because he underestimated how German government policies produced hyperinflation in his lifetime.¹⁹ Chartalist theories are nonetheless overwhelmingly supported by historical research into the origin of modern money. Moreover, Chartalist theory was recognized by classic authors such as Adam Smith (1776: 312): ‘A prince, who should enact that a certain proportion of his taxes should be paid in a paper money of a certain kind, might thereby give a certain value to this paper money’.

For Bell, Smith’s ‘sagacious’ observation identifies a crucial anomaly for metallist theories of money: that government policy causes paper (with no inherent value and no necessary base or reference in precious metal reserves) to nonetheless become widely accepted as money at considerable values. Governments thereby allocate resources, use money for public policy, and determine the value of money in domestic and foreign transactions (this does not imply that governments can do anything they desire with money).

Ironically, state theories of money underestimate how politics and government policies shape money. State mandates f...