The Brazilian Fiscal Crisis: The Lost Credibility

By Tatiana Acar

[7 min read]

 

Assessing how credibility affects both the economy and individuals in a tangible way is a complex issue in the economic debate. We can conceive the delicate concept of confidence through the image of a horse being trained to jump obstacles. In order to gain his trust, the athlete needs to show commitment and respect. With sufficient warning, the horse tends to follow his commands, and both will have a durable relationship. However, unexpectedly forcing it to jump will make the horse suspicious. If surprised, he can harm the athlete and destroy all the environment around him. Worse, once the trust is betrayed, it is hard to recover it. Brazil’s current crisis scenario could be linked to this metaphor since the fiscal misconduct seen in the last years has undermined the population’s confidence and generated great disarray among consumers, businesses, and investors. Output growth has fallen more than 7% in two years[1], causing unemployment more than doubling[2]. Recovering the lost development will consume a large part of Brazil’s next presidential term, which has been predicted by some analysts already[3]. But why has the country reached this stage? What is the relationship between credibility and the level of employment and income?

Credibility is built when people notice, over time, that the government has not only committed to the policy it communicated, but it has also managed to achieve its goals[4]. When a government spends continuously and increasingly, uncertainty about the country’s fiscal solvency tends to be higher. Thus, the effect of fiscal stimulus on the economy and individuals might become counterproductive by pushing up long-term interest rates, inflationary expectations and undermining longer-term growth prospects. This puts the government into a dangerous vicious circle, as the fall in the output causes a drop on tax revenues, further increasing the fiscal imbalance.

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