Don't Blame It on Rio ... or Brasilia Either

The search for better economic policy.
Feb. 12 1999 3:30 AM

Don't Blame It on Rio ... or Brasilia Either

The real is caught in a confidence trap.

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Which brings us to the story of the latest crisis. The IMF program fell apart, predictably, though earlier than most people expected. Still, on the Friday in January when the real was floated things didn't look too bad. The currency didn't fall as much as some feared, and the stock market soared. It looked, in other words, as if Jeff Sachs had been right. Then, over the weekend, Washington officials convinced Brazil to raise interest rates. When the interest rate increase was announced, panic set in and the currency plunged. Instead of helping, in other words, the interest rate increase apparently simply reinforced the vicious circle.

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Maybe it is still possible to push the reset button--to rewind the tape to mid-January and recapture that initial optimism. After firing two central bank heads in close succession, Brazil appointed an aide to George Soros--an interesting move, particularly given the market action over the preceding couple of days. (For more on the recent turmoil, click.) And perhaps the new man can somehow say the magic words, find the formula that will turn self-fulfilling pessimism into self-fulfilling optimism. But win or lose, the story is, let us say, not exactly a wonderful advertisement for either the competence of the IMF or the virtues of the New World Order.

Paul Krugman writes a twice-weekly column for the New York Times and is professor of economics and international affairs at Princeton University. His home page contains links to many of his other articles and essays.

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