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Macroeconomic Review

By Ilan Goldfajn


What is the alternative?


Brazil is depressed, clinically. The country fails to see a way out of its problems. The fiscal problem is 

seen as insoluble. Previous fiscal targets? The country has failed to meet them. Lower targets in the 

present? They are no longer feasible. And what about the future targets? No one believes in promises 

anymore. But what if this time it is for real, with expenditure cuts? Allegedly, there is no space for that 

(even though spending stands above 40% of GDP). And increasing taxes, as was done in the past? 

People won’t accept that any more. The solution thus is to passively accept a primary deficit (that 

makes a total budget deficit of close to 7% of GDP)? Definitely no. Doing so is equivalent to 

choosing higher inflation, deeper recession, lower real wages and worsening income 



To propose a primary deficit (instead of surplus) for the next year’s budget is to implicitly recognize the 

inability to avoid the worst path. It means there is no consensus to transform a current imbalance into a 

future equilibrium. The result will be increasing public debt. And higher sovereign risk. In this case, the 

rating agencies would likely downgrade Brazil's investment rating and investors would reprice Brazilian 

assets, leading to exchange rate depreciation, stock exchange corrections, and higher market interest 



In the absence of other feasible alternatives, inflation is the ultimate solution. The depreciation of the 

real depreciation would translate into higher inflation, and lower incomes (in income in real terms). 

Wages hardly keep up with accelerating inflation, specially when labor market is weakening. In this 

scenario, the poorer loose more, since they financially more vulnerable and consumption takes up a 

larger share of their income.


Inflation is a regressive tax that closes the gap by brute force. In the past, it was Brazil’s classical 

solution. Current leadership in Brazil refuses to opt out of this solution.

But the old solution will face the modern institutions: there are now inflation targets and a central bank 

with the responsibility to meeting them. To avoid higher inflation, economic activity may suffer even 

more. In the absence of adjustment via prices, the economy may need to further adjust through 



The higher sovereign risk reduces investment, hindering activity and weakening the labor market. This 

weakness destroys jobs and forces a decline in real wages, total wage bill and consumption. The 

recession may deepen.


The loss of real income, which disproportionately affects the low-income population, would impact 

income distribution and the new middle class would suffer, being pushed down to the low-income class, 

a traumatic backward movement. 


The developments described above would be the effective result of choosing not to decide. But what is 

the actual alternative?


At present, further spending cuts are seen as very difficult, as well as decreasing social security 

benefits is seen as unpopular and almost impossible. But increasing inflation, losing investment grade, 

deepening the recession and worsening income distribution – is that a valid alternative?


I refuse to believe that a country with so much spending and inefficiency is unable to find room for 

some improvement. Surely, there are low-hanging fruits to be harvested. The counterargument is that, 

unlike the harvesting of fruit in the tropics, improving the economy needs a minimum of organization, 

leadership and some consensus.


We certainly have problems deemed "structural" (meaning, long-standing and difficult to solve). It is 

believed that the Brazilian society has adopted a major "social contract" since at least the 1988 

Constitution, which granted benefits to various groups of people. But these benefits no longer fit inside 

Brazil’s GDP. The tax burden required to afford this welfare state has already paralyzed the economy. 

The debt created to finance this increased spending reached a ceiling, and the risk of losing investment 

grade rating attests to this.


It is a common belief that one has to take advantage of a crisis to make the tough changes: fear of the 

worst turns consolidation and reforms into the lesser evil. In normal times when facing two difficult 

choices, the hope is that a more benign third option would eventually materialize. Decisions are thus 

delayed, waiting for this benign option that never appears. A crisis, on the other hand, forces a decision 

(provided there is a minimum of organization and leadership).


There certainly are hard choices to be made: revising benefits, adjusting the size of the State to the 

available income. This is far from a trivial task. It is easier to give than take. Or engage in self-
deception rather than to accept reality.


But this harsh reality should not be a reason for procrastinating. The tough task needs to be handled 

right here, right now. The policies adopted today are not neutral: they worsen or improve the structural 



Not all is stalled. Some adjustments are underway. The more depreciated exchange rate is already 

reducing the current account deficit and stimulating export or import competing sectors. This is one of 

the few current sources of growth for the Brazilian economy.


Freeing regulated prices brought relief by removing relevant distortions and helping the economy. The 

quasi-fiscal adjustment corrected unsustainable subsidized programs. Investment in infrastructure and 

the reforms of PIS/Cofins and ICMS unification, if approved, are efforts in the right direction.


But it is essential to solve the fiscal problem, in order to see hopes of stabilization and economic 

recovery. This will require the implementation, for example, of budget cuts in the short term (and future 

reforms to limit spending growth in the long term). That could avoiding a crisis, or in other words, avoid 

choosing implicitly the worst option.


**Ilan Goldfajn is chief economist and partner of Itaú Unibanco.

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