https://orcid.org/0000-0003-3997-7129
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Abstract
Severe recessions usually occur in the company of deflation. However, Brazil displayed atypical results in 2015, with a severe recession and double-digit inflation at the same time. Fisher delivered the classical explanation for severe recession and dramatic price level variation. Inspired by Fisher’s model, we elaborated on an explanation for the case of Brazil. The country displayed the essential elements of Fisher’s model: debt disturbances and price-level disturbances. A contractionary fiscal policy triggered the recession, and once contraction started, the price level moved upwards dramatically. Among the government’s spending cuts were subsidies to intermediate inputs. Once the prices of these inputs increased, the general price level followed. In the presence of a recession, nonfinancial corporations saw their costs soar. As a result, they could not entirely pass on the rise in production costs to retail prices. With fewer revenues and smaller profits, production was discouraged. The over-indebted companies decided to use their available resources to pay off debts and avoid bankruptcy, instead of increasing production. Thus, we concluded that a specific type of inflation and the companies’ over-indebtedness could severely aggravate recession.
Notes
1 In 1981, Brazil faced a severe recession of 4.25%, with a yearly inflation rate of around 100% (IBGE Citation2019). Such a case does not bear any resemblance to what happened in 2015. From the mid-1960s until 1994, the Brazilian economy lived under a high inflation regime, where the relationship between inflation and output was unclear or rather tenuous. In a high inflation regime, changes in relative prices become autonomous and are nearly related, to some degree, to their past and expected changes. For more details on the high inflation regime in Brazil, see Cardim de Carvalho (Citation1993).
2 “I have, at present, a strong conviction that these two economic maladies, the debt disease and the price-level disease (or dollar disease), are, in the great booms and depressions, more important causes than all others put together” (Fisher Citation1933, 341).
3 “The over-indebtedness hitherto presupposed must have had its starters. It may be started by many causes, of which the most common appears to be new opportunities to invest at a big prospective profit, as compared with ordinary profits and interest, such as through new inventions, new industries, development of new resources, opening of new lands or new markets. Easy money is the great cause of over-borrowing. When an investor thinks he can make over 100 per cent per annum by borrowing at 6 per cent, he will be tempted to borrow, and to invest or speculate with borrowed money. This was a prime cause leading to the over-indebtedness of 1929” (Fisher Citation1933, 348). Fisher’s description might be further enriched with Keynes words: “The later stages of the boom are characterised by optimistic expectations as to the future yield of capital-goods sufficiently strong to offset their growing abundance and their rising costs of production and, probably, a rise in the rate of interest also. It is of the nature of organised investment markets, under the influence of purchasers largely ignorant of what they are buying and of speculators who are more concerned with forecasting the next shift of market sentiment than with a reasonable estimate of the future yield of capital-assets, that, when disillusion falls upon an over-optimistic and over-bought market, it should fall with sudden and even catastrophic force” (Keynes Citation1973, 315–316).
4 Minsky criticized and further enriched Fisher’s approach: “[he] emphasized over-indebtedness as the initial condition for a debt deflation without explaining how this initial condition was generated, what was a measure of excess indebtedness and where the excess debt was” (Minsky Citation1994, 2). Minsky then offered his own explanation: “In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values” (Minsky Citation1992, 8).
5 Minsky argued that companies could go on a distress selling of assets (securities or bonds), which would be offered for sale, thus reducing their prices and forcing new rounds of distress selling. Minsky pointed out that the difference from his theory to that of Fisher’s was that “… money is more directly linked to asset prices than to either output prices or money wages” (Minsky Citation1994, 3). Besides, Minsky used the expression “to sell position to make position” (Minsky Citation1992, 8) to describe indebted companies’ behaviour. Therefore, at the end of the process, there would be the destruction not only of real assets (highlighted by Fisher) but also of financial assets. Minsky thus concluded that “Fisher’s debt-deflation theory of great Depressions is a special case of the Keynes-Minsky financial instability hypothesis” (Minsky Citation1994, 3).
6 The logical sequence described by Irving Fisher also included impacts of deflation on banking and monetary variables, which have not been presented here because they are unnecessary for our purposes.
7 A few years after Fisher had published his ideas, Keynes, dealing with a potential decline in wages and prices in a situation of acute contraction of the output, stated that: “Indeed if the fall of (…) prices goes far, the embarrassment of those entrepreneurs who are heavily indebted may soon reach the point of insolvency, – with severely adverse effects on investment. Moreover the effect of the lower price-level on the real burden of the national debt and hence on taxation is likely to prove very adverse to business confidence” (Keynes 231973, 264).
8 According to Fisher, this is how the malign sequence initiates: “… at some point of time, a state of over-indebtedness exists, this will tend to lead to liquidation, through the alarm either of debtors or creditors or both” (Fisher Citation1933, 341–342).
9 “If a firm decides to employ workers to use the capital equipment to produce output, it must have enough command over money to pay the wages of the workers and to purchase those goods which it has to purchase from other firms during the period which must elapse before the output can be, conveniently and economically, sold for money” (Keynes Citation1979, 64). Banks advance these resources. Keynes argued that companies’ dependence on banks is not the result of weakness. It is instead a time- and resource-allocation problem. In general, strong companies have resources invested in bonds or other liquid assets that yield a higher interest rate than the one charged by banks for working capital credit. Thus, they prefer to keep their liquid assets and take short-term bank loans. Banks would be interested in offering this kind of credit because of its high liquidity – since companies expect to sell what they produce; this credit is, therefore, a fast-returning asset for banks. In Keynes’ words: “In the first place, loans for working capital are more ‘liquid’ in the sense that the borrower will be frequently turning the goods, financed by such loans, into money, so that the lender will not be ‘locked up’ in security which never comes on to the market as is the case with most fixed capital. In the second place, the needs of individual businesses for working capital are far more variable in amount than their needs for fixed capital, and fluctuate for seasonal and other reasons, even in times of stable output when the requirements of business as a whole are averaging out. Thus, the banks are able to perform a useful service by providing a pool of floating resources which can be placed at the disposal of now this business and now that. Moreover, a banker prefers for obvious business reasons a class of account which involves constant turnover and frequent transactions and combines individual variability with aggregate stability, to business which, once done, means a prolonged lock-up of the bank’s resources and does not involve any further consequential transactions” (Keynes Citation2013b, 84–85).
10 This does not mean that the authors are favorable to the adoption of an inflation targeting regime, but only that this institutional arrangement is currently quite common.
11 Keynes concluded that the fastest and most efficient way out would be through government intervention by investing in public works. For further details on the need for such intervention, see, for example, Keynes (Citation2013a, 148).
12 Between 2006 and 2016, the National Monetary Council (NMC) set the inflation target at 4.5%, with a fluctuation range of ±2%. The NMC is the official government body that sets targets and (upper and lower) limits for Brazilian inflation targets.
13 The use of manufacturing production as a proxy for GDP is well established in Brazilian literature. See Belaisch (Citation2003) and Minella et al. (Citation2003).
14 As for diesel fuel, the rise in prices aimed at improving Petrobras’ (a state-owned company) results and the consequent transfer of its profits to the government. Actually, such measures amount to a cut in subsidies.
15 The “Working Capital Revolving Credit” is the name given by Central Bank of Brazil for short term maturity (up to 365 days) production-related loans.
16 In Brazil, judicial recovery is the economic, administrative, and financial reorganization of a company conducted with court supervision to avoid bankruptcy.
17 Authors’ calculation based on Graph 5 data.
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Notes on contributors
João Sicsú
João Sicsú is at Institute of Economics, Federal University of Rio de Janeiro, Rio de Janeiro, Brazil, [email protected].
Andre de Melo Modenesi
Andre de Melo Modenesi is at Institute of Economics, Federal University of Rio de Janeiro, Rio de Janeiro, Brazil. Researcher of the National Council for Scientific and Technological Development (CNPq), Address: Av. Pasteur, n. 250, sala 115 (Instituto de Economia), Rio de Janeiro, RJ 22.290-240, Brasil, [email protected].
Débora Pimentel
Débora Pimentel is at Department of Economics, Federal Rural University of Rio de Janeiro, Brazil, [email protected] We appreciate the comments by an anonymous referee and Antonio J. Alves Jr. Any errors and omissions are our own. The present research was financially supported by Conselho Nacional de Desenvolvimento Cientifico e Tecnologico.