Money and banking Essay Example | Topics and Well Written Essays - 1500 words

Money and banking - Essay Example In mid 1998, Brazil's consolidated fiscal position was showing primary deficit, as the government expenditure exceeded its income. The current account deficit was approaching 5% of GDP, even as the economy was sliding into recession. The situation was further aggravated when Russia defaulted on its debt payment and external capital flow came to a halt (Fraga, 2000). Floating of Real was the course of action taken by the government in January 1999 with the consequence that the exchange value of Real plunge to an all time low R$2.15. The government realised that any drastic step taken out of distress rather than alleviating the problem could create further imbalances by fuelling inflation. The government was contemplating whether to float, peg and initiate a fixed- rate regime. After looking through all the possibilities the government had announced in March 1999 that the full inflation targeting system would come into force in June 1999. The Brazilian government could have taken recourse to many instruments at its disposal to implement country's economic policy but the government had assigned to the Central Bank the task of keeping the rate of inflation at a low level. ... Another reason for choosing the inflation targeting regime is its' near immunity to political influence in policy decisions. Another purpose of the regime is to coordinate the prospects of inflation. While this contributes towards achieving the target, at the same time, it may enhance the credibility and transparency. The inflation targeting regime helps to buffer the shocks hitting the economy. Due to the flexibility of the system, it can absorb these shocks. Brazil is a country that is still dependent on foreign capital. Introduction of floating exchange rate as a part of the inflation targeting regime will directly absorb part of external shocks. The key points of the inflation targeted regime can be summarized as follows: Inflation target will be established on the basis of variations of a widely known price index The inflation targets as well as the tolerance intervals will be set by the National Monetary Council on a basis of a proposal by the Finance Minister The price index that would be adopted for the purpose of inflation targeting framework will be chosen by the National Monetary Council on the basis of a proposal by the Finance Minister The targets will be considered to have been met whenever the observed accumulated inflation during the period of January-December of each year falls within the tolerance interval In case the targets are breached, the Central bank's Governor needs to issue an open letter addressed to the Finance Minister explaining the causes of the breach, the measures to be adopted to ensure that the inflation returns to the tolerance levels, and the period of time that will be needed for these measures to have effect,