1. Any one: (1) high capital gains taxes, (2) red tape, (3), strong unions, and (4) monopolies. (See "New Economy Hits Snags in Israel" March 27, page A1.)

2. OPEC nations cut oil production. In their meeting last week, they were expected to boost production to lower the world price of crude oil. (See "Why Oil Price Tripled Even as Nations Strove to Limit Its Gyrations" March 27, page A1, "OPEC Ministers, Seeking to Ease Prices, Target 1 Million Barrels a Day More Oil, March 27, page A2, "OPEC Still Can't Agree on Output Boost" March 28, page A3, "Most of OPEC Agrees to Boost Output" March 29, page A3)

3. PC and software makers would be allowed to modify the Microsoft source code so that rival products can be added and Microsoft would offer a version of windows without Internet Explorer. (See "Microsoft Proposal Makes Big Concessions" March 27, page A3.)

4. The drugs are useful many years past the expiration date-in some cases 15 years. The question is whether pharmaceuticals use the expiration dates for marketing and profit reasons. (See "Many Medicines Prove Potent for Years Past Their Expiration Dates" March 28, page A1.)

5. Even though the average 30-year fixed rate mortgage is 8.23%, above the 6.98% from a year earlier, the U.S. housing market remains strong. Sales in February rose 6.7% in February. For the full report, go to http://nar.realtor.com and http://www.doc.gov (See "Home Sales Rebound Despite Rate Rises," March 28, page A2 and "New-Home Sales Continue at Brisk Pace" March 30, page A2.)

6. No. Our reliance on oil has diminished from a decade ago. Oil prices were this high 3 years ago and did not ignite inflation. (See "Greenspan Dismisses Rise in Price of Oil as Harbinger of Inflation" March 28, page A2.)

7. According to this Wall Street Journal article, consumers perceive computers to depreciate so quickly that it's better to buy a new computer than to pay to fix existing ones. (See "PC Problems? Send in the Geeks!" March 28, page B1.)

8. No. The typical (median) household on the wealth spectrum owns no stocks. Beware of the difference between mean and median! (See "The Many Ways to Play the Averages" March 28, page C1.)

9. Higher interest rates, higher energy prices and stock market volatility all contributed to a drop in the consumer confidence index in March. Go to http://www.confererenceboard.org for the full report. (See "Uncertainty Pares Consumer Confidence," March 29, page A2.)

10. OPEC ministers agreed to create price band that will be maintained by supply adjustments. The OPEC president will be able to call oil producers to request supply adjustments without a formal meeting of oil ministers. (See "OPEC Plans Automatic Supply Changes," March 30, page A3.)

11. The speed limit is a 3.5% annual growth rate in real GDP. Real GDP rose at a 5.0 percent annual rate in the fourth quarter of 1999. (See "Economy Grew Strongly in 4th Quarter," March 31, A2)

12. The Medicare trust fund is expected to be depleted in 2023 (up 18 years from what was forecast just 3 years ago) and the Social Security trust fund is expected to be depleted in 2037 (3 years later than forecast earlier). (See "Future Looks Rosier for Social Security, Medicare" March 31, A2)

13. Save the current surplus by reducing the debt. (See "Saving the Surplus Will Save Social Security," March 31, A18) Return to Questions

3/28/2000
The Wall Street Journal
Page A22
(Copyright (c) 2000, Dow Jones & Company, Inc.)

SAO PAULO, Brazil -- Since a clumsy devaluation forced Brazil's currency to begin trading freely on world markets 14 months ago, few imagined the Latin American giant would ever have to guard against its currency getting too strong.

But with the economy returning to growth, inflation under control, foreign investment surging, and the public purse in relatively solid shape, that is precisely what appears to be happening.

1. Has the Brazilian real appreciated or depreciated recently? What factors have led to this change? Explain your answer.

Surging Friday in the wake of a stronger-than-expected report on the government's accounts, Brazil's currency, the real, ran smack into its own central bank, which intervened in support of the U.S. currency by buying dollars -- the first time it is believed to have done so since the January 1999 devaluation.

The Brazilian currency was approaching 1.70 reals per dollar when the central bank came in to buy dollars on the open market, according to traders. The currency then quickly retreated to 1.73 reals to the dollar, and was at 1.749 in late afternoon New York trading. Still, that represents a sharp appreciation from levels of over two reals per dollar a year ago.

2. What did Brazil's central bank have to do to lower the value of the real? Demonstrate your answer with supply and demand curves. What is the effect of this action on the Brazilian economy?

"I had assumed that the real would strengthen to 1.70 by the end of this year," said Ernest W. Brown, Morgan Stanley Dean Witter's chief economist for Latin America. "But we've seen all the movement I was looking for this year occur in just the first quarter." To observers of Brazil's economic policy under the central bank's president, Arminio Fraga, the central-bank intervention suggests he is eager to nip in the bud any talk of the currency again becoming overvalued. The bank is also said to favor a slightly weaker real in the interest of making Brazilian exports more competitive on growing world markets.

Finally, Brazilian companies are loath to borrow in dollars overseas if they think the dollar is only going to get stronger. That's because a rising dollar makes the cost of paying back debt more expensive in local-currency terms. The ability to borrow overseas is important to Brazilian corporate-growth plans since domestic interest rates remain extremely stiff.

3. What is the effect of a weaker real on Brazilian exports and imports? On the Brazilian economy?

Some believe the central bank is now simply trying to push the real back down after having allowed it to appreciate, in part, for political reasons. A stronger real was desirable, for example, while Congress was pressuring the administration to adopt a new minimum wage pegged at $100 per month. The eventual increase, an 11% bump to 151 reals, looked a lot more generous with the real rising against the dollar. A strong real was also preferable with oil prices running higher, since Brazil is a big oil importer.

4. How does a stronger real affect the politics of a minimum wage in Brazil? How does it affect imports of oil?

In the near term, there are a number of factors to suggest the central bank may have to work to keep the real from resuming its appreciation. Foreign direct investment -- nearly $5 billion in just the first two months of the year -- is on record pace. A number of Brazilian corporate-equity issues in the hot Internet sector are expected in coming months, sure to attract even more dollars.

Investors are particularly impressed with signs of Brazil's commitment to taming its budget deficit: In January, the government posted its highest primary budget surplus (excluding debt-service costs) since 1991.

Inflation is well within the central bank's targets. Given those factors, Mr. Brown figures the real is undervalued by more than 20% and could be fairly valued as high as 1.30 to the dollar. Most economists expect the real will finish the year at between 1.81 and 1.90 per dollar, according to a central-bank survey.

SAO PAULO, Brazil -- In a surprise move, Brazil's central bank cut its benchmark lending rate for the first time in more than six months to its lowest nominal level since President Fernando Henrique Cardoso introduced an inflation-busting economic plan in 1994.

Citing reduced fuel-price inflation as a result of a new Organization of Petroleum Exporting Countries' agreement to curb climbing oil prices, the bank dropped the equivalent of its prime lending rate to 18.5% from 19%, effective Wednesday. The rate had stood at 19% since September and is now down from a peak of 45% a year ago, when rates shot up to stem capital flight in the wake of a shuddering currency devaluation.

At its monthly monetary policy meeting last week, the central bank had left interest rates unchanged, citing lingering uncertainties on the inflation front. It did adopt a bias toward lower rates, which allows bank President Arminio Fraga to cut rates unilaterally, without a meeting of Brazil's monetary policy committee. The rate cut was the first outside the scope of a regular policy committee meeting since June.

"The [committee] would have cut rates last week had it had not been for the uncertainties on international markets," bank monetary-policy director Luiz Fernando Figueiredo told reporters. Brazil counts on oil imports for most of its fuel needs and manages its interest rates based on inflation targets. The central bank forecasts a rise in consumer prices of 6% this year, plus or minus two percentage points, a target most expect Brazil to hit. Consumer prices rose 8.9% last year.

The rate cut, in addition to trimming about $1.2 billion in interest from government debt payments this year, "is also consistent with the idea that the central bank is keen on leaning against recent currency strength" in the interest of defending the competitiveness of exports, J.P. Morgan economist Marcelo Carvalho said in a note to investors. Strong capital inflows have pushed up Brazil's currency, the real, sharply this year. It ended barely changed Wednesday at 1.7450 reals to the dollar.

5. What do you predict will be the effect of the central bank action on the value of the Brazilian real?

Positive Brazil sentiment also is helping the government lengthen its debt maturities, a sign that investors are growing more comfortable with the country's long-term prospects. Mr. Figueiredo said the average maturity of government treasury bonds will likely widen to more than 21 months in April vs. 17 months this month and only eight months in January. Brazil's economic policy committee is next scheduled to meet April 19. Few analysts expect another rate move until then.

Chapter references appear after the answer to each question.

1. The Brazilian real has appreciated in value against the dollar. That is, a real can buy more dollars or conversely one dollar can buy fewer reals. An economic expansion, low inflation and foreign investment are factors cited in the article leading to the appreciation of the real. Low inflation increases the competitiveness of Brazilian goods and increases demand exports and therefore the demand for the real. As the demand for the real rises its value increases. Increased foreign investment, likewise leads to greater demand for the Brazilian real and an increase in its value. An economic expansion, however, is can have an ambiguous effect on the exchange rate. Although increased income leads to more imports (increasing the supply of reals and lowering its value), increased income also could mean higher investor confidence and increased foreign investment (decreasing the supply of and increasing the demand for the real leading to a higher value). It must be the factors leading to appreciation outweigh the effect of greater income on the value of the real. [McConnell: 38 (25); Colander: 15] Return to article.

2. The central bank had to enter the market for the real and buy U.S. dollars with its holdings of reals. This shifts the supply of reals to the right, lowering equilibrium price and raising equilibrium quantity as shown in the graph below.

Since the central bank is buying up dollars and supplying more real, the supply of real is increasing. This will tend to reduce interest rates in Brazil and have an expansionary effect on the Brazilian economy. [McConnell: 38 (25); Colander: 15] Return to article.Return to article.

3. A weaker real makes imports more expensive for Brazilians but exports from Brazil more competitive (cheaper). More expensive imports and cheaper exports will tend to reduce a trade deficit (or raise a surplus) and provide a boost to economic growth in Brazil. [McConnell: 38 (25); Colander: 15] Return to the article.Return to article.

4. The minimum wage is paid in local currency, but pegged at $100 per month. That means that if the real appreciates after the minimum wage bill is passed, that minimum wage is worth more. Suppose that at the time the minimum wage is established the exchange rate is 1.50 real per dollar. The minimum wage is set at 150 reals per month. If the real were to appreciate to 1.3 real per dollar, those receiving the minimum wage will be able to purchase more dollar-denominated imports with their wages. The same reasoning applies to imported oil. A stronger currency means that the recent rise in world oil prices will have less effect on domestic oil prices. For example, if the exchange rate were 1.5 real per dollar, a $30 barrel of oil will cost 45 reals. If the exchange rate were 1.3 real per dollar, that same barrel of oil will cost 39 real. [McConnell: 38 (25); Colander: 6 and 15] Return to article.Return to article.

5. An easing of monetary policy would be expected to reduce the value of the real through its effects on interest rates (lower), income (higher) and prices (higher). This more recent move by the central bank is consistent with its intervention in foreign exchange markets to keep the real from appreciating further. [McConnell: 38 (25); Colander: 15] Return to article.

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