Part I<\/strong><\/h4>\nA consensus has emerged in Brazil (and elsewhere) blaming Rousseff\u2019s \u201cnew economic matrix\u201d policies for the country\u2019s worst crisis since the Great Depression (see here<\/a>, here<\/a>, here<\/a>, here<\/a>, and here<\/a>). With the introduction of policy stimulus through ad hoc tax breaks for selected sectors seen as failing to boost economic activity and the deterioration of the fiscal balance — which posted a public sector primary budget deficit in 2014 after fifteen years of primary fiscal surpluses — opponents argued that government intervention was the problem. It provided the basis for the opposition to demand the return of the old neoliberal macroeconomic policy tripod and fiscal austerity policies. There was virtually a consensus that spending cuts would create confidence, reduce interest rates, and stimulate private investment spending. Fiscal austerity<\/a>, according to this view, would be expansionary and pave the way for economic growth.<\/p>\nHowever, there is an alternative interpretation of the Brazilian crisis: as the result of endogenous processes that created destabilizing forces, reducing margins of safety and increasing financial fragility. As Minsky put it, \u201cstability is destabilizing.\u201d The success of traditional stabilization policies over substantial periods has created endemic financial fragility and rising domestic and external private indebtedness, causing the deterioration of the current account and the fiscal balance. This crisis was aggravated by the pursuit of structural stabilization policies in 2015, in an attempt to produce a fiscal surplus, which caused further deterioration of fiscal deficits and government debt followed by the collapse of economic activity.<\/p>\n
1. Minsky\u2019s Instability Theory<\/strong><\/p>\nIn Minsky\u2019s work, he extended Keynes\u2019s investment theory of the cycle to add the financial theory of investment to demonstrate that, in a modern capitalist economy, investment decisions have to be financed and the liability structure created due to those investment decisions will generate endogenous destabilizing forces. His theory of the business cycle, grounded in his financial theory of investment, shows that a capitalist economy is inherently unstable due to the interconnectedness of balance sheets of economics units and cash flows. From this perspective, while the financial system in a capitalist economy plays a key role in providing the financing to business to promote the real capital development of the economy, it also plays a key role in creating destabilizing forces.<\/p>\n
Minsky\u2019s framework not only sheds light on how to detect unsustainable financial practices, the position adopted in this paper is that the current Brazilian crisis does fit with Minsky\u2019s instability theory.<\/p>\n
2.<\/strong> Destabilizing Effects of Stability and Declining Margins of Safety<\/strong><\/p>\nCentral to Hyman P. Minsky\u2019s financial instability hypothesis was that periods of economic stability and economic progress lead to dynamic internal changes characterized by hedge, speculative, and Ponzi financial positions (see Minsky 1975, 1982, 1986). Minsky (1986) focused on the destabilizing effects of stability and declining margins of safety. The purchase of assets through the issuance of debt is central to his financial instability theory. He pointed out that periods of growth and tranquility validate expectations and existing financial structures, which change the dynamics of human behavior leading to endogenous instability, increasing risk appetite, mispricing of risky positions, and the erosion of margins of safety and liquid positions. That is, over periods of prolonged expansion fragility rises, exposing the economy to the possibility of a crisis. This rise in financial fragility, in turn, has the potential to lead to a slowdown in economic growth, stagnation, or even a recession.<\/p>\n
Minsky argues that continued success encourages and enables more investment, which in turn creates more income through the traditional spending multiplier and profits — as shown by Kalecki-Levy\u2019s profit equation — but it also increases the magnitude of risk underpricing. Minsky argues that during economic expansions, market participants show greater tolerance for risk and forget the lessons of past crises so firms gradually move from safe financial positions to riskier positions.<\/p>\n
For instance, during an expansion led by an investment boom, profits tend to increase. The profit boom affects behavior and allows firms to meet outstanding financial commitments. During this phase of the expansion both firms and lenders are willing to expand their balance sheets by increasing leverage.<\/p>\n
3. A Minsky Crisis in Brazil? Does the Brazilian crisis fit with Minsky’s theory of the business cycle?<\/strong><\/p>\nThe 2000s led to a unique economic environment conducive to Brazilian economic expansion and improvement in economic conditions for the majority of people (Kregel 2009). The Lula administration\u2019s policies that expanded aggregate demand occurred during this ambiguous period leading to fortuitous outcomes. In spite of a growing consensus that Brazil navigated relatively smoothly the 2007-2008 global financial crisis by implementing a series of countercyclical policies — see Barbosa 2008; De Paula et al 2015; Ferrari-Filho et al 2014, Silva and Harris 2012; Rezende 2015 — Brazil\u2019s policy response to the euro crisis has been criticized for being too late, poorly designed, and too small to bring about economic growth (De Paula et al 2015).<\/p>\n
Prior to the economic crisis of 2007-2008, the Brazilian economy experienced extremely favorable external conditions such as increasing global demand for emerging market exports and rising financial flows to emerging markets (Kregel 2009). Some critics of the Brazilian government argued that the boom in commodity prices, buoyant external demand, and massive foreign flows into Brazil\u2019s economy were solely due to external tailwinds, which fueled the positive economic performance during the last decade. This group tended to overlook domestic policies designed to foster private demand.<\/p>\n
Brazilian economic policymakers, by contrast, proudly pointed to government policies designed to boost growth. Even though following these events policy-makers and economists have pointed to the robustness of Brazil\u2019s financial system and its resilience to the global financial crisis by focusing on conditions that existed in the U.S. financial system prior to the \u201csubprime\u201d crisis, they overlooked the importance of the destabilizing effects of stability on financial structures, the development of new sources of instability and the need to redesign the regulatory structure to continually meet its objectives of financial stability and providing finance for development.<\/p>\n
To be sure, the positive economic performance was driven by both domestic and external factors. Under the Lula administration, the Brazilian economy grew, generating jobs, raising real incomes (minimum wage increases, income transfer programs), reducing poverty and income inequality[1]<\/sup><\/sup><\/a>.\u00a0 Prior to the crisis, banks (public and private) had roughly doubled their lending as a share of GDP, increasing consumer loans (Rezende 2015a). Moreover, following the global financial crisis, public investment increased (PAC I and II, long-term investment funding via BNDES) and housing financing increased (My House, My Life) to meet Brazil\u2019s investment needs and to act as a countercyclical tool to offset the decline in private demand (Rezende 2015).<\/p>\nBrazil\u2019s unemployment rate hit record lows, real incomes increased, bank credit roughly doubled since 2002, it had accumulated US$ 376 billion of reserves as of October 2014, and lifted the external constraint. The poverty rate and income inequality declined sharply due to government policy and social inclusion programs, lifting 36 million out of extreme poverty after 2002. Moreover, the resilience and stability of Brazil\u2019s economic and financial systems received attention as they navigated relatively smoothly through the 2007-2008 global financial crisis.<\/p>\n
The exceptionally positive performance of the Brazilian economy during the New Millennium characterized by high growth rates, external surplus balance, rising foreign direct investment flows, rising employment levels, and improving debt burdens of the public sector were the counterpart of deregulated developed country financial systems, which drove asset prices up such as commodity prices, improving developing country terms of trade, allowed rising private sector debt thus supporting the demand for imported goods, and generated a positive carry trade resulting in short-term capital flows to emerging markets (Kregel 2009, p.5).<\/p>\n
However, following the Great Recession, the combination of substantial U.S. private sector deleveraging and shrinking the U.S. current account deficit led to a sharp decline in the demand for emerging market exports due to structural changes in international markets (figure 1) and the end of the commodities cycle. As an export-led growth strategy requires at least one nation to run current account deficits, the absence of robust external demand (figure 1) and the conditions that prevailed before the 2007-2008 global financial crisis, required a shift in Brazil\u2019s development strategy towards the domestic market to fill the spending gap.<\/p>\n
Figure 1. Global current account balances (% of world GDP)<\/em><\/p>\n![\"Rezende_Minsky](\"http:\/\/multiplier-effect.org\/files\/2016\/08\/Rezende_Minsky-Meets-Brazil_Fig1.png\")
<\/a><\/p>\nSource: IMF WEO, October 2015<\/em><\/p>\nThe bubble period showed a remarkable turnabout of the current account balance, from a deficit to a surplus position (figure 2).<\/p>\n
Figure 2. Current account and trade balance (% of GDP)<\/em><\/p>\n![\"Rezende_Minsky](\"http:\/\/multiplier-effect.org\/files\/2016\/08\/Rezende_Minsky-Meets-Brazil_Fig2.png\")
<\/a><\/p>\nSource: IBGE<\/em><\/p>\nThe consequences of the crisis were clear. Global financial markets and U.S. households started deleveraging, thus producing a new global structure impacting global trade, industrial production, and finance (figure 3).<\/p>\n
Figure 3. World Trade and Industrial Production<\/em><\/p>\n![\"Rezende_Minsky](\"http:\/\/multiplier-effect.org\/files\/2016\/08\/Rezende_Minsky-Meets-Brazil_Fig3.png\")
<\/a><\/p>\nSource:\u00a0 CPB Netherlands, Brazilian Central Bank (BCB), Funcex<\/em><\/p>\nThe 2007-2008 global financial crisis, and its immediate impact on the financial and real sectors, triggered policy responses to deal with its consequences. Although the policy response produced a quick increase in world trade and production, which contributed significantly to Brazil\u2019s export growth and terms of trade during this time period (figure 3), since 2010 there has been a sharp decline in world trade and production and a reversal of Brazil\u2019s terms of trade (figure 4).<\/p>\n
Thus, the contribution of net exports to economic growth declined substantially since 2011 (figure 3). Moreover, while the commodity price boom improved the terms of trade (figure 4), the sharp decline in global commodity prices has slowed output growth among commodity-dependent economies (IMF WEO 2015).<\/p>\n
Figure 4. Commodity Price Indices (2005 = 100) and terms of trade<\/em><\/p>\n![\"Rezende_Minsky](\"http:\/\/multiplier-effect.org\/files\/2016\/08\/Rezende_Minsky-Meets-Brazil_Fig4.png\")
<\/a><\/p>\nSource: IMF, WEO, Oct. 2015, Funcex<\/em><\/p>\nThe success of countercyclical policies has misled policy-makers to believe that pre-crisis growth strategies would again be effective. However, the positive conditions experienced by emerging market economies were not reestablished.<\/p>\n
In spite of Brazil\u2019s relative success dealing with the immediate consequences of the crisis, since the aftermath of the 2007-2008 global financial crisis emerging-market economies, and Brazil in particular, have underperformed. With the Chinese slowdown, resource exporters, including Brazil, faced the consequences of declining commodity prices (figure 5). The pre-crisis development strategy supported by export-led growth and the excessive reliance on external finance reached its limits. The combination of a slowdown of a powerful driver of global growth, changed external conditions, and failure to implement policies to support domestic demand growth contributed to end Brazil\u2019s boom with a bust.<\/p>\n
Figure 5. Brazil GDP, China GDP and commodity prices<\/em><\/p>\n![\"Rezende_Minsky](\"http:\/\/multiplier-effect.org\/files\/2016\/08\/Rezende_Minsky-Meets-Brazil_Fig5.png\")
<\/a><\/p>\nSource: JP Morgan 2016<\/em><\/p>\nThe impacts of the crisis in Brazil, in particular, were substantial. It moved from a current account surplus equal to 1.25 percent of GDP in 2006 to a deficit equal to 3.6 percent of GDP in 2013, being third-largest deficit economy (after the US and UK) in the world according to a recent IMF report (table 1).<\/p>\n
Table 1. Global imbalances<\/em><\/p>\n![\"Rezende_Minsky](\"http:\/\/multiplier-effect.org\/files\/2016\/08\/Rezende_Minsky-Meets-Brazil_Table1.png\")
<\/a><\/p>\nSource: IMF WEO, October 2014, p.118<\/em><\/p>\nMeanwhile, the underlying force from the demand side was sustained by a sharp increase in private credit (figure 6), which ultimately led the private sector from a surplus position to a deficit, that is, total private expenditure exceeded private disposable income, which implied a rapid build up in indebtedness of the private sector. In particular, the Brazilian economy experienced rising private sector leverage relative to the growth of government securities (figure 6). As is well known, growth strategies based on private sector deficits are unsustainable (Minsky 1975, 1982, 1986).<\/p>\n
However, there is an alternative interpretation of the Brazilian crisis: as the result of endogenous processes that created destabilizing forces, reducing margins of safety and increasing financial fragility. As Minsky put it, \u201cstability is destabilizing.\u201d The success of traditional stabilization policies over substantial periods has created endemic financial fragility and rising domestic and external private indebtedness, causing the deterioration of the current account and the fiscal balance. This crisis was aggravated by the pursuit of structural stabilization policies in 2015, in an attempt to produce a fiscal surplus, which caused further deterioration of fiscal deficits and government debt followed by the collapse of economic activity.<\/p>\n
1. Minsky\u2019s Instability Theory<\/strong><\/p>\n In Minsky\u2019s work, he extended Keynes\u2019s investment theory of the cycle to add the financial theory of investment to demonstrate that, in a modern capitalist economy, investment decisions have to be financed and the liability structure created due to those investment decisions will generate endogenous destabilizing forces. His theory of the business cycle, grounded in his financial theory of investment, shows that a capitalist economy is inherently unstable due to the interconnectedness of balance sheets of economics units and cash flows. From this perspective, while the financial system in a capitalist economy plays a key role in providing the financing to business to promote the real capital development of the economy, it also plays a key role in creating destabilizing forces.<\/p>\n Minsky\u2019s framework not only sheds light on how to detect unsustainable financial practices, the position adopted in this paper is that the current Brazilian crisis does fit with Minsky\u2019s instability theory.<\/p>\n 2.<\/strong> Destabilizing Effects of Stability and Declining Margins of Safety<\/strong><\/p>\n Central to Hyman P. Minsky\u2019s financial instability hypothesis was that periods of economic stability and economic progress lead to dynamic internal changes characterized by hedge, speculative, and Ponzi financial positions (see Minsky 1975, 1982, 1986). Minsky (1986) focused on the destabilizing effects of stability and declining margins of safety. The purchase of assets through the issuance of debt is central to his financial instability theory. He pointed out that periods of growth and tranquility validate expectations and existing financial structures, which change the dynamics of human behavior leading to endogenous instability, increasing risk appetite, mispricing of risky positions, and the erosion of margins of safety and liquid positions. That is, over periods of prolonged expansion fragility rises, exposing the economy to the possibility of a crisis. This rise in financial fragility, in turn, has the potential to lead to a slowdown in economic growth, stagnation, or even a recession.<\/p>\n Minsky argues that continued success encourages and enables more investment, which in turn creates more income through the traditional spending multiplier and profits — as shown by Kalecki-Levy\u2019s profit equation — but it also increases the magnitude of risk underpricing. Minsky argues that during economic expansions, market participants show greater tolerance for risk and forget the lessons of past crises so firms gradually move from safe financial positions to riskier positions.<\/p>\n For instance, during an expansion led by an investment boom, profits tend to increase. The profit boom affects behavior and allows firms to meet outstanding financial commitments. During this phase of the expansion both firms and lenders are willing to expand their balance sheets by increasing leverage.<\/p>\n 3. A Minsky Crisis in Brazil? Does the Brazilian crisis fit with Minsky’s theory of the business cycle?<\/strong><\/p>\n The 2000s led to a unique economic environment conducive to Brazilian economic expansion and improvement in economic conditions for the majority of people (Kregel 2009). The Lula administration\u2019s policies that expanded aggregate demand occurred during this ambiguous period leading to fortuitous outcomes. In spite of a growing consensus that Brazil navigated relatively smoothly the 2007-2008 global financial crisis by implementing a series of countercyclical policies — see Barbosa 2008; De Paula et al 2015; Ferrari-Filho et al 2014, Silva and Harris 2012; Rezende 2015 — Brazil\u2019s policy response to the euro crisis has been criticized for being too late, poorly designed, and too small to bring about economic growth (De Paula et al 2015).<\/p>\n Prior to the economic crisis of 2007-2008, the Brazilian economy experienced extremely favorable external conditions such as increasing global demand for emerging market exports and rising financial flows to emerging markets (Kregel 2009). Some critics of the Brazilian government argued that the boom in commodity prices, buoyant external demand, and massive foreign flows into Brazil\u2019s economy were solely due to external tailwinds, which fueled the positive economic performance during the last decade. This group tended to overlook domestic policies designed to foster private demand.<\/p>\n Brazilian economic policymakers, by contrast, proudly pointed to government policies designed to boost growth. Even though following these events policy-makers and economists have pointed to the robustness of Brazil\u2019s financial system and its resilience to the global financial crisis by focusing on conditions that existed in the U.S. financial system prior to the \u201csubprime\u201d crisis, they overlooked the importance of the destabilizing effects of stability on financial structures, the development of new sources of instability and the need to redesign the regulatory structure to continually meet its objectives of financial stability and providing finance for development.<\/p>\n To be sure, the positive economic performance was driven by both domestic and external factors. Under the Lula administration, the Brazilian economy grew, generating jobs, raising real incomes (minimum wage increases, income transfer programs), reducing poverty and income inequality[1]<\/sup><\/sup><\/a>.\u00a0 Prior to the crisis, banks (public and private) had roughly doubled their lending as a share of GDP, increasing consumer loans (Rezende 2015a). Moreover, following the global financial crisis, public investment increased (PAC I and II, long-term investment funding via BNDES) and housing financing increased (My House, My Life) to meet Brazil\u2019s investment needs and to act as a countercyclical tool to offset the decline in private demand (Rezende 2015).<\/p>\n Brazil\u2019s unemployment rate hit record lows, real incomes increased, bank credit roughly doubled since 2002, it had accumulated US$ 376 billion of reserves as of October 2014, and lifted the external constraint. The poverty rate and income inequality declined sharply due to government policy and social inclusion programs, lifting 36 million out of extreme poverty after 2002. Moreover, the resilience and stability of Brazil\u2019s economic and financial systems received attention as they navigated relatively smoothly through the 2007-2008 global financial crisis.<\/p>\n The exceptionally positive performance of the Brazilian economy during the New Millennium characterized by high growth rates, external surplus balance, rising foreign direct investment flows, rising employment levels, and improving debt burdens of the public sector were the counterpart of deregulated developed country financial systems, which drove asset prices up such as commodity prices, improving developing country terms of trade, allowed rising private sector debt thus supporting the demand for imported goods, and generated a positive carry trade resulting in short-term capital flows to emerging markets (Kregel 2009, p.5).<\/p>\n However, following the Great Recession, the combination of substantial U.S. private sector deleveraging and shrinking the U.S. current account deficit led to a sharp decline in the demand for emerging market exports due to structural changes in international markets (figure 1) and the end of the commodities cycle. As an export-led growth strategy requires at least one nation to run current account deficits, the absence of robust external demand (figure 1) and the conditions that prevailed before the 2007-2008 global financial crisis, required a shift in Brazil\u2019s development strategy towards the domestic market to fill the spending gap.<\/p>\n Figure 1. Global current account balances (% of world GDP)<\/em><\/p>\n Source: IMF WEO, October 2015<\/em><\/p>\n The bubble period showed a remarkable turnabout of the current account balance, from a deficit to a surplus position (figure 2).<\/p>\n Figure 2. Current account and trade balance (% of GDP)<\/em><\/p>\n Source: IBGE<\/em><\/p>\n The consequences of the crisis were clear. Global financial markets and U.S. households started deleveraging, thus producing a new global structure impacting global trade, industrial production, and finance (figure 3).<\/p>\n Figure 3. World Trade and Industrial Production<\/em><\/p>\n Source:\u00a0 CPB Netherlands, Brazilian Central Bank (BCB), Funcex<\/em><\/p>\n The 2007-2008 global financial crisis, and its immediate impact on the financial and real sectors, triggered policy responses to deal with its consequences. Although the policy response produced a quick increase in world trade and production, which contributed significantly to Brazil\u2019s export growth and terms of trade during this time period (figure 3), since 2010 there has been a sharp decline in world trade and production and a reversal of Brazil\u2019s terms of trade (figure 4).<\/p>\n Thus, the contribution of net exports to economic growth declined substantially since 2011 (figure 3). Moreover, while the commodity price boom improved the terms of trade (figure 4), the sharp decline in global commodity prices has slowed output growth among commodity-dependent economies (IMF WEO 2015).<\/p>\n Figure 4. Commodity Price Indices (2005 = 100) and terms of trade<\/em><\/p>\n Source: IMF, WEO, Oct. 2015, Funcex<\/em><\/p>\n The success of countercyclical policies has misled policy-makers to believe that pre-crisis growth strategies would again be effective. However, the positive conditions experienced by emerging market economies were not reestablished.<\/p>\n In spite of Brazil\u2019s relative success dealing with the immediate consequences of the crisis, since the aftermath of the 2007-2008 global financial crisis emerging-market economies, and Brazil in particular, have underperformed. With the Chinese slowdown, resource exporters, including Brazil, faced the consequences of declining commodity prices (figure 5). The pre-crisis development strategy supported by export-led growth and the excessive reliance on external finance reached its limits. The combination of a slowdown of a powerful driver of global growth, changed external conditions, and failure to implement policies to support domestic demand growth contributed to end Brazil\u2019s boom with a bust.<\/p>\n Figure 5. Brazil GDP, China GDP and commodity prices<\/em><\/p>\n Source: JP Morgan 2016<\/em><\/p>\n The impacts of the crisis in Brazil, in particular, were substantial. It moved from a current account surplus equal to 1.25 percent of GDP in 2006 to a deficit equal to 3.6 percent of GDP in 2013, being third-largest deficit economy (after the US and UK) in the world according to a recent IMF report (table 1).<\/p>\n Table 1. Global imbalances<\/em><\/p>\n Source: IMF WEO, October 2014, p.118<\/em><\/p>\n Meanwhile, the underlying force from the demand side was sustained by a sharp increase in private credit (figure 6), which ultimately led the private sector from a surplus position to a deficit, that is, total private expenditure exceeded private disposable income, which implied a rapid build up in indebtedness of the private sector. In particular, the Brazilian economy experienced rising private sector leverage relative to the growth of government securities (figure 6). As is well known, growth strategies based on private sector deficits are unsustainable (Minsky 1975, 1982, 1986).<\/p>\n<\/a><\/p>\n<\/a><\/p>\n<\/a><\/p>\n<\/a><\/p>\n<\/a><\/p>\n<\/a><\/p>\n
![\"Rezende_Minsky](\"http:\/\/multiplier-effect.org\/files\/2016\/08\/Rezende_Minsky-Meets-Brazil_Fig6.png\")
<\/a>