Exchange Rate Regime

St Comp Int Dev (2009) 44:122
DOI 10.1007/s12116-008-9033-9
Exchange Rate Regime, Central Bank Independence,

and Political Business Cycles in Brazil
Taeko Hiroi
Published online: 30 September 2008

# Springer Science + Business Media, LLC 2008
Abstract This article examines policy consequences of electoral cycles and

exchange rate regime choices in Brazil. The literature on opportunistic political
business cycles maintains that governments adopt expansionary economic policies
before elections to mobilize voters support. However, research findings in Latin
America based on the theory has been inconclusive. I argue that the lack of
conclusive evidence in Latin America stems from measurement errors common in
the use of cross-national aggregate data. Using Brazils monthly data from 1985 to
2006, this article shows that there are electorally induced fiscal cycles under fixed
and crawling peg exchange rate regimes and electorally induced monetary cycles
under floating exchange rates only when the nations central bank is not
independent. Indeed, accounting for Brazils unique economic contingencies and
longitudinal variations in the de facto central bank independence, its public policy
behavior remarkably resembles that of the more affluent, economically stable OECD
countries.
Keywords Exchange rate . Central Bank . Brazil . Political business cycle . Election
Introduction
What are the policy consequences of exchange rate regime choices? The choice of
exchange rate regimes in developing countries has caused heated debates over the
last decade among academics and policymakers. In the early to mid-1990s, a fixed
exchange rate regime was hailed as a way to stabilize inflation-prone economies.
Argentina adopted a regime, known generally as a currency board, that fixed the
peso to the US dollar on a one-to-one basis. While not adopting a truly fixed
currency, Brazil did opt for a periodically adjusted band system after a short
T. Hiroi (*)
Department of Political Science, The University of Texas at El Paso,
500 W. University Avenue, El Paso, TX 79968, USA
e-mail: thiroi@utep.edu
experiment with a floating regime in 1994. At the turn of the century, there seemed
to be a polarization, with countries either adopting full dollarization or moving to a
fully floating currency. Ecuador and El Salvador chose full dollarization. In contrast,
in January 1999, after struggling with rising pressures on its currency, the Brazilian
government introduced a floating exchange rate regime, ending its long tradition
(with sporadic breaks) of a crawling peg system. Almost 3 years later, Argentina did
away with its decade-old currency board system and floated its peso.
This article presents a political-economic analysis of macroeconomic policies in
post-authoritarian Brazil. The literature on opportunistic political business cycles
argues that governments adopt expansionary economic policies before elections to
mobilize support of the voters (Nordhaus 1975; Lindbeck 1976; Lewis-Beck 1988;
Alesina et al. 1993; Keech 1995; Alesina and Roubini 1997; Clark and Nair Reichert
1998; Clark and Hallerberg 2000). The use of expansionary macroeconomic policies
by governments is conditioned by the type of exchange rate regime and the degree of
central bank independence in a given country (Clark and Hallerberg 2000). That is,
governments increase public expenditures and/or decrease taxes before elections
when the exchange rate is fixed. On the contrary, they increase the money supply or
reduce interest rates when the exchange rate is flexible if the central bank is not
independent. The theory of political business cycles has found extensive support
when applied to OECD (Organization for Economic Cooperation and Development)
countries (most recently, Clark and Hallerberg 2000). However, research findings in
Latin America have been inconclusive (Ames 1987; Remmer 1993; Borsani 2001;
Clark et al. 2003; Amorim Neto and Borsani 2004).
There are at least two possible reasons that can account for the lack of conclusive
evidence in Latin America. One reason is that the theory simply does not travel to
developing countries. The other is measurement error. Institutions tend to be weak in
developing countries, and consequently there are often wide gaps between formal
and actual practices. Recognizing the deficiencies in relying on legal statutes, certain
scholars therefore have attempted to gauge de facto central bank independence and
exchange rate regimes. For example, Alex Cukierman (1992) and Cukierman,
Steven Webb and Bilin Neyapti (1992) proposed a new measure of central bank
independence based on the turnover rate of central bank governors.1 Similarly,
Eduardo Levy-Yeyati and Federico Sturzenegger (2003, 2005) point out the
discrepancies often found in the exchange rate regimes reported to the International
Monetary Fund and a countrys actual exchange rate behavior. Due to these gaps,
Levy-Yeyati and Sturzenegger classify de facto exchange rate regimes based on
three indicators: changes in the nominal exchange rate; the volatility of nominal
exchange rates; and the volatility of international reserves. These new measures
represent the current state of art in measuring the actual behavior of central bank
independence and exchange rate regimes.
Yet, at the same time, they are not perfect measures. Their most serious
drawbacks are that, as is often the case with any aggregate data, they may be
insensitive to the variations that may occur over time and across countries. For
instance, central bank independence based on governors turnover rates requires one
to average the rates over certain period of timein the studies by Cukierman (1992)
1
See also De Haan and Kooi (2000).
and Cukierman et al. (1992), the averages are for a 10-year period. As a result,
variation during this time frame will not be captured by this measure. Central bank
governors may also stay in office for different reasons in different countries.
Although turnovers of central bank governors may be low in some countries because
the governments are constrained from intervening in bank affairs, central bank
governors in other countries may stay in office because they do whatever possible to
please the governments. In the latter case, turnover rates are low precisely because
central banks are dependent.
This article analyzes the consequences of exchange rate regime choice and
electorally motivated public policymaking in the case of Brazil. William Clark and
Mark Hallerberg (2000) represent major advancement in the study of opportunistic
political business cycles by taking into account the policy constraining effects of
critical economic institutions. However, its application to developing countries
would require consideration of possible discrepancies that may exist between de
facto and de jure exchange rate regimes and central bank independence. One of the
major contributions of this article is to explicitly consider the actual behavior of
these economic institutions as well as their statutory status. By conducting a case
study with disaggregated data, the empirical analyses also simultaneously avoid the
aforementioned pitfalls that previous efforts at measuring de facto central bank
independence have entailed. The evidence provides strong support for the theory in
the Brazilian experience: There are fiscal cycles when the exchange rate is fixed or
pegged (i.e., crawling pegs), and there are monetary cycles if and only if the central
bank is dependent and the exchange rate is flexible. Therefore, although prior
studies applying the theory of political business cycles to Latin America yielded
inconclusive results, this study shows that when the peculiarities of and longitudinal
differences within the country and deeds of central economic institutions are
accounted for in the data analyses, Brazils fiscal and monetary policy behavior has a
remarkable resemblance to the behavior observed in more affluent, economically
stable OECD countries.
This article proceeds as follows. The second section, which follows next, presents
a theoretical background and prior research on opportunistic political business
cycles. The third section analyzes political business cycles in Brazil. It first closely
examines Brazils fiscal and monetary policymaking and its economic contingencies
characterized by numerous economic stabilization programs and currency changes. It
then performs simple time-series regression analyses on fiscal and monetary policies.
The results of the econometric analyses show that electorally induced fiscal cycles
occur under relatively fixed exchange rates, and that electorally motivated monetary
cycles happen under flexible exchange rates only when the central bank is not
independent. The fourth section concludes.
Exchange Rate Regime, Central Bank Independence, and Opportunistic

Political Business Cycles
How electoral competition affects macroeconomic policy is a central issue in the
political economy literature. The political business cycle tradition argues that a
government employs economic tools to enhance its electoral standings. One stream
of the tradition, which began with William Nordhaus (1975),2 stresses that
policymakers expand monetary and fiscal policies immediately before elections to
boost economic growth. Scholars working with this theory argue that there is an
informational asymmetry between policymakers and voters. Knowing this information gap, opportunistic politicians wishing to continue in office manipulate policy
instruments on the assumption that voters evaluate government performance
retrospectively. That is, voters reward politicians for good economic performance
by reelecting them and punish ones for bad economic conditions by voting them out.
The preelectoral manipulation of policy instruments may cause macroeconomic
disequilibria, which may be adjusted by contractionary policies in the postelectoral
period. The theory of political business cycles has been tested extensively and found
strong support, especially with regard to OECD countries (Nordhaus 1975; Lindbeck
1976; Lewis-Beck 1988; Alesina et al. 1993; Keech 1995; Alesina and Roubini
1997; Clark and Nair Reichert 1998; Clark and Hallerberg 2000).
Many scholars have also used the theory of political business cycles in their
attempts to explain macroeconomic behavior in Latin American countries. Rather
than applying the theory directly, most of these scholars modified it to consider the
unique realities of developing countries that may not be found in advanced industrial
democracies. Despite these efforts, research based on the theory as applied to Latin
America has had mixed results.
Barry Ames (1987) was one of the first to use the theory to explain Latin American
governments budgetary behavior. He argues that patterns of government spending are
influenced by politicians survival strategies and identifies two politically induced
spending cycles: electoral and military coup cycles. His multivariate analysis of
government spending shows strong evidence for preelectoral expenditure expansion
and some evidence for spending increases by post-coup military governments,
although the latter finding is not statistically significant. Yet, in more recent study,
Octavio Amorim Neto and Hugo Borsani (2004) argue that elections do not affect
overall government spending although they do worsen primary balances.
Karen Remmer (1993) also finds limited evidence for the electoral cycle argument
in her multivariate regression of four indicators of macroeconomic policy and
performance (money supply, fiscal balance, exchange rate stability, and inflation).
Given the mixed findings, Remmer speculates that politicians may wish to
manipulate the economy for electoral gains, but economic instabilities and
international policy constraints limit their ability to influence economic performance.
In contrast, Borsani (2001) argues that political business cycles do exist in Latin
America, but the effect of elections is conditional upon majorities in Congress. His
research of Latin American democracies during the 19791998 period shows that
only the governments that enjoy a majority in Congress are capable of manipulating
GDP growth rates in election years, although minority governments are also likely to
be inclined to do the same.
Studies in Jeffrey Frieden and Ernesto Steins (2001) edited volume also indicate
the existence of electorally induced cycles in exchange rate policy in Latin American
countries. Exchange rates directly affect citizens purchasing power. They also help
2
Another tradition in the literature on political business cycles investigates the relationship between
partisan cycles and macroeconomic policy outcomes. The classic study of partisan cycles is Hibbs (1977).
control inflation. Therefore, Frieden and Stein contend that a government facing
elections tries to postpone a major depreciation or devaluation until after the
elections are conducted even when immediate corrections in exchange rate policy are
desirable from a long-run perspective.
There is an important shortcoming in the political business cycle literature as
applied to Latin America. In general, research in this field does not make an explicit
prediction as to which macroeconomic policy or policies politicians seeking
reelection ought to pursue. The studies reviewed here examine a variety of
macroeconomic policies and outcomes as their dependent variables, ranging from
total government spending and GDP growth rates to exchange rate policy, budget
balance, inflation, and money supply.
Clark and Hallerberg (2000) develop a theoretical framework that predicts when
governments will choose either fiscal policy or monetary policy to manipulate the
macroeconomy. They begin with what has become known as the MundellFleming
(MF) model.3 It stipulates that only two of the following three policy options are
possible at any one time: capital mobility; fixed exchange rates; and autonomous
monetary policy. A corollary to this is that under mobile capital and a fixed
exchange rate, monetary policy is not autonomous because the nations central bank
must stand ready to adjust interest rates or the money supply to maintain the
prevailing exchange rate. Under a floating exchange rate regime, monetary policy is
not only autonomous, but is effective at changing the nations economic output.
Conversely, fiscal policy is effective in affecting output under fixed regimes but
ineffective under floating regimes because an expansionary fiscal policy causes the
exchange rates to appreciate, which in turn will suppress the countrys export.
Clark and Hallerberg (2000) assume that governments understand the implications of this model, and they use this knowledge to decide which policy tools are
effective in manipulating the macroeconomy before elections. The first question
concerns capital mobility: if capital is not mobile, then governments can use both
types of policies. Under capital mobility, the type of exchange rate regime becomes
important. Governments pursue monetary expansions when the exchange rate is
flexible while they pursue fiscal expansions when the exchange rate is fixed.
The authors test the argument with a data set composed of OECD countries. They
focus on changes in monetary and fiscal policy instruments rather than in overall
macroeconomic outcomes, which could be influenced by other factors. They find
that a monetary expansion in the form of a higher money supply occurs in
preelectoral periods in countries with capital mobility and flexible exchange rates,
while a fiscal expansion as increasing budget deficits is found in countries with open
capital and fixed exchange rate regimes.
However, preelectoral monetary expansion is also conditioned by the status of a
countrys central bank. Clark and Hallerberg (2000) find that independent central
banks prevent monetary cycles in their study of OECD countries. Interestingly, when
examining eastern European countries, Hallerberg et al. (2002) discover that
countries with independent central banks experience monetary contractions during
preelectoral periods. The authors speculate that the newly created central banks in
Mundell (1963); Fleming (1962).
Eastern Europe may be signaling to markets their independence from governments

during precisely the period one would expect dependent banks to expand the money
supply. Similar behavior may be expected of independent central banks in Latin
America where economic crises and numerous stabilization programs have been
ubiquitous.
There is an important consideration to make in the analysis of economic
institutions in developing countries. In Clark and Hallerberg (2000), central banks
statutory independence is assumed to be their actual degrees of independence.
Although their legal status may be a good measure of their actual independence in
OECD countries, it may not be an accurate indicator of de facto independence in
many developing countries (Cukierman 1992 and Cukierman et al. 1992). In general,
institutions and the rule of law are much feebler in developing countries than in
advanced industrial democracies. Consequently, a central bank that is independent
on paper may not deter electorally induced monetary cycles because it is in fact
politically controlled. As such, we must pay close attention to the actual behavior of
central banks as well as their statutory status. In the end, There is no theory that
says it matters what the rules say. There is only a theory that says it matters what the
behaviour is (Forder 1996: 44).
Recognizing that measuring central bank independence from their legal statutes is
unreliable, many scholars have attempted to gauge de facto central bank
independence. The pioneer in this field is Cukierman (1992; see also Cukierman
et al. 1992). Cukiermans de facto independence measure relies on the turnover rate
of central bank governors and on the assumption that politically vulnerable central
banks will have their governors replaced frequently before they complete their
legally defined terms (if there is any).
Although the Cukierman measure may represent the current state of art in
assessing actual central bank independence, it is not a perfect measure. Its most
serious drawbacks are that, as is often the case with any aggregate data, it may be
insensitive to cross-national and longitudinal variations. For instance, as I note
above, central bank independence based on governors turnover rates requires one to
average the rates over certain period of timein the study by Cukierman (1992) and
Cukierman et al. (1992), the averages are for a 10-year period. As a result, variation
during this time frame will not be captured by this measure. Central bank governors
may also stay in office for different reasons in different countries. Although
turnovers of central bank governors may be low in some countries because the
governments are constrained from intervening in bank affairs, central bank
governors in other countries may stay in office because they do whatever possible
to please the governments. In the latter case, turnover rates are low precisely because
central banks are dependent (De Haan and Kooi 2000: 646, fn. 2). Perhaps because
of the imprecise measures of central bank independence by either statute reading or
turnover rates, recent research on the relationship between central bank independence and macroeconomic outcomes (such as inflation) has been inconclusive (De
Haan and Kooi 2000).
Rather than jumping to the conclusion that central bank independence does not
matter, we need to develop a measure of central bank independence that is sensitive
to both longitudinal and cross-sectional variations and de jurede facto gaps.
Although it may be a difficult task to do cross-nationally, it is feasible to create a
fine-tuned measure of central bank independence if one focuses on a single or a few

countries. Short of a reliable cross-national measure of central bank independence,
subsequent empirical analyses will focus on a single country, Brazil.
To recapitulate the theoretical argument, electorally motivated politicians use
macroeconomic policy instruments to enhance their chances of winning elections.
However, their repertoire of available policy instruments is constrained by capital
mobility and two economic institutions: exchange rate regimes and central bank
independence. As for the question of capital mobility, many scholars argue that
capital became highly mobile by the end of the 1970s.4 Therefore, I presume that
capital was mobile throughout the period of this study (19852006) and concentrate
on other key variables. This leads to two hypotheses. First, there should be a fiscal
expansion in the form of larger budget deficits in the year before an election under
fixed exchange rates only. Second, there should be a monetary expansion in a higher
money supply in the year before an election under a flexible exchange rate and a
dependent central bank only.
Empirical Analyses
This section analyzes the impact of elections and central bank independence on
fiscal and monetary policy under different exchange rate regimes in Brazil since the
countrys return to democracy in March 1985. Legislative elections are held every
4 years in Brazil. Deputies are elected for 4-year terms and senators for 8-year terms.
All of the Chamber of Deputies seats are renewed every 4 years, while the Senates
elections are staggered, renewing one third or two thirds of its seats at each election.
Reelections are allowed for both houses. The first elections for the Senate and the
Chamber after democratization took place in November 1986, followed by elections
in 1990, 1994, 1998, 2002, and most recently, 2006. Brazils first civilian president
after two decades of military rule was chosen through an electoral college in January
1985 for a 5-year term with no immediate reelection. With the 1989 presidential
elections, Brazil returned to the use of direct popular vote. The 1989 elections were
the only presidential elections that were not held concurrently with the legislative
elections. In 1994, a constitutional revision shortened the presidential term to
4 years, and presidential and legislative elections have been held concurrently ever
since. The 1995 constitutional amendment permitted an immediate reelection of an
incumbent president. The amendment benefited the two presidents since its
promulgation, Fernando Henrique Cardoso and Luiz Incio Lula da Silva, both of
whom ran for reelection and renewed their terms in 1998 and 2006, respectively.
Economically, Brazil has gone through complex and chaotic experiences. Since
the reestablishment of democracy, Brazil has had six different currencies (see
Table 1) and at least nine major stabilization plans (see Table 2) to fight chronically
high inflation and balance of payments crises.5 During the same period of only two
decades (19852006), there have been 17 finance ministers and 17 central bank
presidents.
4
See Gowa (1983); Odell (1982); and Webb (1991).
See Baer and Paiva (1998) for Brazils economic stabilization plans.
Table 1 Brazilian currency system

Currency
Period
Legislation
Cruzeiro (Cr$)
Cruzado (Cz$)
15 May 197027 Feb 1986 Resolution no. 144 (1970); Law no. 7214 (1984)
28 Feb 198615 Jan 1989 Decrees nos. 2283 and 2284(1986) and Resolution
1100 (1986)
Cruzado Novo (NCz$) 16 Jan 198915 Mar 1990 Presidential decree no. 32 (1989) and Resolution
1565 (1989)
Cruzeiro (Cr$)
16 Mar 199031 Jul 1993 Presidential decree no. 336 (1993), Resolution
no. 2010 (1993), and Law 8697 (1993)
Cruzeiro Real (CR$)
1 Aug 199330 Jun 1994 Presidential decree 336 (1993), Law 8697 (1993),
and Resolution 2010 (1994)
Real (R$)
1 July 1994present
Presidential decree 542 (1994), Law 9069 (1995),
and Resolution 2082 (1994)
The unidade real de valor is not included in the table
Source: Brazil n.d. History of the Brazilian Currency Systems. Banco Central do Brasil, Department of
Economics.
Exchange rate regimes determine the degree to which the currency is allowed to
float freely or be fixed against some other currency (Frieden and Stein 2001, 3). At
one extreme is a fixed regime in which a nations currency is completely fixed to
another currency through, for example, dollarization and a currency board. At the
other extreme lies a completely flexible (or floating) regime where the value of the
currency is determined solely by the market without government intervention.
Between them are various managed regimes with varying degrees of exchange rate
control. In Brazil, governments adopted crawling peg regimes rather than strictly
fixed regimes during most of the post-authoritarian years until 1999, which allowed
the currency to depreciate against the dollar at a controlled rate (see Fig. 1).6
Nonetheless, there were short and intermittent experiments with both fixed and
floating regimes. The Sarney government introduced fixed regimes twice during its
19851989 term. The first attempt at a fixed regime occurred in the March to
September period in 1986 as part of an economic stabilization program known as the
Cruzado Plan. With the failure of the stabilization plan, the traditional peg system
was reinstalled. The second experiment with the fixed regime also short-lived; it was
adopted from January to April 1989 as part of another stabilization program, the
Summer Plan. From May 1989 to the installment of the 1994 Real Plan, the
Brazilian exchange rate regime was based on a crawling peg. In March 1994,
Fernando Henrique Cardoso, then finance minister, created a new inflation
indexation system, the unidade real de valor (URV; the unit of real value), which
was to be replaced by a new currency, the real, in July 1994. During this transition
period, the value of the URV was fixed to the U.S. dollar on a one-to-one basis, and
the government intervened in the currency to maintain the URVs parity with the
dollar (Bonomo and Terra 2002: 140). Government contracts and taxes were
denominated in the URV, and the government encouraged the private sector to do the
same, although the actual transactions were still conducted in the cruzeiro real.
See Bonomo and Terra (2001) for the evolution of Brazilian exchange rate regimes since 1964.

Table 2 Stabilization programs
in Brazil
9
President
Year
Stabilization program
Jos Sarney
1985
1986
1987
1988
1989
199091
1991
1991
1994
Orthodoxy
Cruzado Plan
Bresser Plan
Rice and Beans
Summer Plan
Collor I
Collor II
Orthodoxy
Real Plan
Fernando Collor
Source: Baer and Paiva

(1998: 90, Table 5.1).
Itamar Franco
When the new currency, the real, was circulated on July 1, 1994, the government
adopted a floating exchange rate regime. However, the value of the real immediately
appreciated against the dollar, leading to the abandonment by the Cardoso
government of the floating regime in February 1995. In March, the Cardoso
government launched an official target zone exchange rate system, which in practice
worked like a crawling peg system. This target system was embraced until the
currency crisis in late-1998. In January 1999, the Cardoso governmentreelected
for a second mandatereintroduced a floating rate system, which continues to be
Brazils exchange rate regime in 2006.
Fiscal Policy in Brazil
In Brazil, budget-proposal making and its execution are concentrated in the Ministry
of Planning, Budget, and Administration (the Ministry of Planning, hereafter) and
the Ministry of Finance. The Ministry of Planning drafts a budget proposal based on
revenue estimates and budget requests by sector (i.e., spending) ministries. The
proposal is then submitted to Congress where it is examined and amended. The budget
proposal must be approved by both Congress and the president of the republic.
Nevertheless, the approval of the proposed budget is not an automatic guarantee of its
execution. In a given fiscal year, the Ministry of Financethe Treasury Department to
be more specificmonitors revenues and expenditures and exercises great discretion
over the release of funds.7 Successive Brazilian presidents have extensively used this
discretionary budgetary power to reward their supporters and punish their opponents
in Congress.
There have been certain efforts to control fiscal deficits in Brazil. The government
has regarded budget deficits as contributing to economic instability and high
inflation in the country. Therefore, various economic stabilization programs adopted
since democratization included some provisions about budget control. In the high
inflation era (19851994), moreover, the government gradually learned not only to
7
Brazilian legislators call this authorized budget (oramento autorizativo). Many members of Congress
do not view the authorized budget favorably. In August 2006, the Brazilian Senate approved a
constitutional amendment proposal that would make the executive branch carry out the budget as
approved by Congress (oramento impositivo). As of this writing, the proposal is under consideration in
the Chamber of Deputies.
10

URV
Floating
Peg
Floating
Pegged
Fixed
URV
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
Fixed
1994.7-1995.2, 1999.1-Present
1985.3-1986.2, 1986.10-1988.10, 1989.5-1994.2, 1995.3-1998.12
1986.3-1986.9, 1989.1-1989.4,
1994.3-1994.6
Fig. 1 Exchange rate regimes, 19852006
coexist with high inflation, but also to take advantage of it to control the budget. The
government, for example, indexed revenues to inflation but did not index
expenditures. This discriminatory indexation method permitted the government to
generate primary surpluses artificially.8 In the aftermath of the currency crisis in
19981999, the Fiscal Responsibility Law was approved in Congress. This law
made it obligatory for the government to generate primary surpluses.
Despite these formal and informal mechanisms to control spending, a balanced
budget has not been the norm in Brazil. Some government officials and legislative
advisors in Congress attested when I interviewed them that there has been enormous
lobbying by all sorts of political actors to release funds for their programs, and that
they developed their strategies to fund their programs accordingly. For instance,
almost as a rule, Congress tries to overestimate the revenues and underestimate the
expenditures. Infighting within the executive branch has also been very intense.
Sector ministries try to pressure the government for greater expenditures. One of the
strategies these sector ministries developed is known in Brazil as inverted
priorities. According to this strategy, the sector ministries spend first on projects
of low priority, and as the budgets allocated to them dwindle, they increase pressures
on the president and the finance ministry to release more funds to them so that they
can implement projects about which the government cares most. A top Finance
Ministry official described the relationships between ministers with respect to the
budget as follows. They [the relationships] are not characterized by cooperative
games. They [sector ministries] always try to cheat us.9 Another official
characterized the relationships as follows: We want to save; they want to spend.
They are politically appointed; we are technocrats.10 The president mediates this
conflict to prevent a government split, and according to government officials, former
president Cardoso was a good mediator.
The patterns of annual budget balances demonstrate oscillation. Figure 2 shows
the budget balance as a percentage of GDP in Brazil, 19852006. The patterns of
8
Interview with a Finance Ministry official on July 11, 2002.
10
Interview with Finance Ministry officials on July 15, 2002.
11
7.00
Floating Regimes
Election Year
5.00
3.00
2006
2005
2004
2003
2002
2001
2000
1999
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
-1.00
1985
1.00
-3.00
-5.00
-7.00
Fig. 2 Annual budget balance as a percentage of GDP in Brazil, 19852006. Budget figures are based on
the Resultado Financeiro do Tesouro (Brazil 2006. Tesouro Nacional, Ministrio da Fazenda). The 2006
figure is based on budget and GDP data for January to September 2006
oscillation do appear to correspond to electoral cycles. Brazilian legislative elections

occurred in 1986, 1990, 1994, 1998, 2002, and 2006. The only presidential elections
that were not held concurrently with the legislative elections happened in 1989, and
we do not have enough elections to differentiate the effects of presidential elections
from those of legislative elections. Figure 2 indicates that the Brazilian government
ran budget deficits in all (1986, 1989, 1998, 2002, and 2006) but two (1990 and
1994) election years.
Since Brazil changed exchange rate regimes at various times during this period,
and since other nonelectoral factors may have influenced budget behavior, I
performed OLS regression analyses in which the dependent variable is the change in
the monthly budget balance as a percentage of monthly GDP. In regards to the
classification of exchange rate regimes, there are only two short episodes of
completely fixed regimes and they both occurred in election years. This problem led
me to classify fixed and crawling peg exchange rates together. Therefore, the
comparison made will be between relatively fixed exchange rate regimes against
floating regimes. Although it may be an imprecise measure of fixed regimes, it is still
sensitive to longitudinal variation of exchange rate regimes because it is coded on a
monthly basis. One possible consequence of this classification decision is that
having statistical significance may be more difficult.11
The other key variable is election. I coded 1 the month in which presidential and/
or legislative elections took place and the 11 preceding months.12 I also included a
11
As a robustness check, I reestimated both fiscal and monetary cycle models using a sample excluding
completely fixed periods. The findings were practically identical in both instances. See Appendix 2.
12
As stated previously, most legislative and presidential elections were held concurrently during the
period of this study. The only presidential election that did not coincide with legislative elections occurred
in 1989. As such, we do not have enough nonconcurrent elections to differentiate the effects of
presidential elections from those of legislative elections.
12
series of control variables that potentially influence the budget balance. These
include GDP growth rates, interest rates, prior budget levels, and various
stabilization programs. Interest rates were highly skewed, so they were transformed
into the natural logarithm scale. Data sources and definitions are found in
Appendix 1.
Table 3 reports estimation results. The regression results (model 1) support the
hypotheses. The budget balance significantly deteriorates (by 1.32 percentage point
of monthly GDP) during election years only when exchange rates are fixed or
pegged. Election alone (that is, when the exchange rate regime is flexible) has no
statistically significant effect on the budget balance. This is exactly what the theory
predicts. The results also show that of numerous stabilization programs implemented
Table 3 Conditional effects of
elections on changes in the fiscal
balance under fixed and flexible
exchange rate regimes in Brazil,
19852005
Dependent variable: change in monthly

budget balance as % of GDP
Election
Fixed/peg
Election fixed/peg
Conditional coefficients
Election under fixed regime
(fixed/peg=1)
Election under flexible regime
(fixed/peg=0)
GDP growth
Logged interest rate
Cruzado plan
Bresser plan
Rice and beans
Summer plan
Collor I
Collor II
Immediate action plan
Real plan
Entries are unstandardized coefficients. Entries in parentheses

are standard errors
****p0.001; ***p0.01; **p
0.05; *p0.1 (two-tailed test)
Monthly budget balance as %

of GDP (t1)
Change in monthly budget balance
as % of GDP (t1)
Constant
Adjusted R2
N
Model 1
Model 2
0.42
(0.86)
1.23
(0.76)
1.73
(1.16)
0.04
(0.81)
0.31
(0.52)
2.06**
(1.00)
1.32*
(0.80)
0.42
(0.86)
0.35***
(0.12)
0.20
(0.16)
2.31
(1.69)
2.11
(1.39)
2.58**
(1.26)
2.23
(1.43)
4.31***
(1.61)
0.61
(1.08)
1.12
(1.55)
1.10
(0.67)
0.69****
(0.08)
0.16**
(0.06)
0.47
(0.66)
0.40
248
2.10****
(0.62)
0.04
(0.81)
0.24**
(.10)
2.38**
(1.05)
4.76****
(1.40)
0.59****
(0.07)
0.20****
(0.06)
0.83*
(0.47)
0.40
248
13
during the high inflation era, only the Collor I program (19901991) was
significantly effective in reducing budget deficits. The Sarney governments Rice
and Beans program (1988), on the other hand, contributed to the deterioration of the
budget balance. There is also evidence of countercyclical fiscal policy: the budget
balance deteriorates as GDP growth slows down. Finally, there is strong evidence
that the prior level of budget surplus/deficit constrains the governments budget
behavior with a higher surplus in the previous month decreasing the budget balance
in the current month, and a greater deficit in the previous month improving budget
performance in the current month.
Model 2 is a truncated model in which only political variables and control
variables that were statistically significant (at least at p0.1) in Model 1 were
included. The estimation results indicate that the effect of the electoral variable is
even stronger than in model 1. During electoral periods, the budget balance
deteriorates by 2.1 percentage points of GDP when there is a fixed or peg regime.
This relationship is significant at p=0.001, but elections have no budgetary impact
when the exchange rate regime is flexible. Again, we find strong evidence to support
the theory.
Monetary Policy in Brazil
In various countries, central banks play a pivotal role in determining monetary
policy. A politically independent conservative central bank is considered a guardian
of price stability. In Brazil, the degree of its central banks independence has
changed over time as the institutions roles were redefined.
Today, the Central Bank of Brazil (Banco Central do Brasil or BCB) has two
missions: price stability and stability of financial institutions.13 However, these had
not always been the only roles expected of the central bank. Until 1986, Brazil had
no treasury department in the Ministry of Finance. The BCB instead assumed the
tasks of the National Treasury and worked with the Ministry of Finance. It was also
possible for the government to influence the money supply directly during the first
year of the Sarney administration. During this period, there existed an account called
the movement (or monetary) account in the BCB through which the central bank
supplied funds to the state-controlled Banco do Brasil, which in turn provided credit
lines for government programs. In 1986, this movement account was closed, the
Secretariat of National Treasury was finally established, and the national budget
accounts were unified.14 In return, the BCB began to issue notes and bonds that year.
Although the BCB was relieved from acting as the treasury and the governments
monetary account was abolished in 1986, these changes did not grant the central
bank much autonomy. One of the measures of de facto central bank independence is
the turnover rate of central bank governors (Cukierman 1992). Between 1987 and
1995, the turnover of central bank presidents averaged greater than one per year. The
Banks missions also mounted to 22 items, ranging from price stability to economic
growth. The government also frequently intervened in BCB affairs. For example,
13
14
Interview with a central banker on July 5, 2002.
Before the unification of the national budget accounts, there were at least three such accounts that were
not centrally controlled, which made it difficult to monitor and control the national budget.
14
President Itamar Franco fired BCB President Paulo Cesar Ximenes Alves Ferreira
(March 26September 9, 1993) over a dispute on the treatment of pre-dated
checks.15 In various aspects, the BCB was not politically independent.
Although there was no legal change in the BCB statute, the Bank enjoyed much
independence during the two terms of the Cardoso government. Monetary policymaking during the Cardoso era occurred in the National Monetary Council presided
by Minister of Finance. The BCB participated in the Council with a vote on
monetary policymaking. The Council determined monetary policies in the meeting
held at the last week of every month. The BCB then executed these policies without
government interference. Hence, the BCB gained operational independence from
the government. In fact, President Cardoso never called BCB President Armnio
Fraga for intervening in BCB operation.16 Scholarly work also attests to the BCBs
increased autonomy. Marcus Holanda and Leonardo Freire (2002), for instance,
measured BCB independence based on economic outcomes and found that there is a
tendency for an increase in independence since 1994.
Indeed, during the 2002 elections, with a strong possibility for the victory of the
left-wing Workers Party in the presidential elections, one of the central debates in
the government, Congress, the BCB, and media was on how to preserve central bank
independence earned during the Cardoso presidency and not whether the central
bank should be independent. The government proposal was to grant the BCB president
a fixed term that would not coincide with electoral cycles. However, this proposal
required an amendment to Article 192 of the countrys Constitution on financial
institutions and it did not pass the Congress before the change of government.
After taking office in January 2003, President Lula and his economic team
pursued very conservative economic policies both to fight inflationary pressures and
to gain investors confidence. As for the status of the central bank, the Brazilian
Congress approved and promulgated a constitutional amendment to Article 192 in
May 2003, thereby opening a door towards granting formal independence to the
central bank. Yet the Lula government found strong opposition within its legislative
coalition, especially the presidents own Workers Party and other leftist parties. As
such, despite many talks about central bank autonomy, the government did not
vigorously pursue its realization. Then, in August 2004, President Lula issued a
decree (Medida Provisria no. 207) granting the central bank governor the status of
a minister.17 Proponents of central bank independence immediately and severely
criticized this measure. Congressional and legal disputes followed, but the decree
was converted into law and the constitutionality of the measure was upheld by the
nations Supreme Federal Court, but with this remark by the courts president: With
the upholding of the decree, we will have a central bank governor who will be
subject to the appointment and dismissal by the President of the Republic. As such,
the intended autonomy of the Central Bank is incompatible with this model.18
15
16
Interview with a central banker on July 5, 2002.
17
The national press reported that Lula issued the decree to protect the then BCB Governor Henrique
Meirelles from a series of scandals in which he was involved.
18
Meirelles tem status de ministro, Correio Braziliense, 6 May 2005: A-11.
15
Based on these findings, I consider the BCB as dependent until 1995 and
independent throughout the two Cardoso administrations and the beginning of the
Lula government. I consider the BCB dependent once again from August 2004 with
the issuance of the controversial decree and its conversion into law (Law No. 11036
of 2004). Article 2 of the law reads, The rank of Governor of the Central Bank of
Brazil is at this time transformed into the rank of Minister of the Republic (Brazil
2008). In the literature on central bank independence, one of the key aspects
concerns appointments and dismissals of central bank governors (Jcome and
Vzquez 2005). A central bank is considered not independent if its governor is
subject to the appointment and dismissal by the head of government at will as
implied by the ministerial status. Therefore, as the Supreme Federal Court
presidents understanding indicates, Brazils current model compromises the banks
autonomy.19 Measured this way, during March 1985October 2006, the central bank
was dependent for a total of 145 months (37 months under flexible exchange rates
and 108 months under fixed or pegged regimes) while it was independent during
115 months (69 months under flexible regimes and 46 months under a pegged
regime).
How has monetary policy behaved in post-authoritarian Brazil? Have there been
monetary electoral cycles under a floating exchange rate regime with a dependent
BCB that have not been observed under any other conditions? Table 4 presents the
results of monetary regressions.20 Appendix 1 lists variable definitions and sources.
The dependent variable is monthly changes in the seasonally adjusted money supply
(M1), namely (m1t m1t 1)/m1t 12. Model 1 considers both presidential and
legislative elections. Unlike budgetary policies, which are subject to congressional
amendment and authorization, Congress does not have any direct role in monetary
policymaking. Therefore, I ran, as a robustness check, another regression (shown in
model 2) in which I consider only presidential elections. In addition, since there may
be some controversy regarding the degree of central bank independence after August
2004,21 I reestimated the regression (shown under model 3) excluding the potentially
disputable period. Since the results of all three regressions are substantively identical, I
will focus on model 1 in interpreting the results.
As in fiscal policies, most major economic stabilization programs did not affect
changes in the money supply. The only exceptions are Collor I and the Real Plan,
which, after controlling for various potentially confounding factors, are associated
with the expansion of the money supply while they were in force. Monthly inflation
rates, as expected, have a positive and significant relationship with the money
supply. In addition, the months in which currency changes took place (February
19
My measure of central bank independence is not based on an absolute scale, but rather assesses the
banks relative autonomy over time. My decision to consider the bank not independent from August 2004
is based on its current status compared to its previous status before the issuance of the decree.
20
As with the fiscal analysis, Appendix 2 presents monetary regression results using an alternative
definition of the exchange rate regime.
21
Although I defined the central bank as dependent since August 2004 due to granting the ministerial
status through a presidential decree, some observers and practitioners of monetary policy and central bank
behavior may argue that the banks operational independence was not affected by such a legal change.
16
Table 4 Monetary regression in
Brazil, 19852001

Dependent Variable:
monthly change in the
seasonally adjusted
money supply (M1)
Election
Fixed/Peg
CBI
Election*CBI
Election fixed/peg
CBI fixed/peg
Election CBI
fixed/peg
Monthly inflation rate
Cruzado plan
Bresser plan
Rice and beans
Summer plan
Collor I
Collor II
Immediate action plan
Real plan
Currency change
GDP growth
Entries are unstandardized coefficients. Entries in parentheses

are standard errors
****p0.001; ***p0.01; **p
0.05; *p0.1 (two-tailed test)
Monthly change in the

seasonally adjusted
M1 (t1)
Constant
2
Adjusted R
N
Model 1
2.83**
(1.28)
0.29
(1.22)
0.17
(0.69)
2.76*
(1.51)
2.54
(1.58)
1.91
(1.94)
2.44
(1.97)
0.62
(0.39)
0.13***
(0.04)
0.19
(1.50)
0.004
(1.13)
0.27
(1.00)
0.73
(1.31)
3.93*
(1.65)
0.12
(0.89)
0.17
(1.26)
2.02*
(1.18)
7.80****
(1.45)
0.02
(0.12)
0.44****
(0.06)
1.85
(1.35)
0.67
237
Model 2
2.82**
(1.28)
0.36
(1.16)
0.17
(0.69)
2.76*
(1.52)
2.61
(1.55)
1.98
(1.89)
2.51
(1.94)
0.64*
(0.37)
0.13****
(0.04)
0.04
(1.37)
0.04
(1.11)
0.29
(1.00)
0.64
(1.23)
4.12***
(1.45)
0.15
(0.88)
0.18
(1.26)
2.05*
(1.18)
7.74****
(1.43)
0.02
(0.12)
0.44****
(0.06)
1.93
(1.32)
0.67
237
Model 3
4.05*
(2.21)
1.03
(2.46)
2.17
(2.23)
4.07*
(2.36)
3.16
(2.51)
0.73
(3.46)
3.00
(2.76)
0.81**
(0.41)
0.14***
(0.04)
1.13
(1.60)
0.27
(1.16)
0.61
(1.04)
1.27
(1.40)
3.17*
(1.75)
0.39
(0.93)
0.05
(1.30)
0.80
(1.45)
7.42****
(1.50)
0.08
(0.13)
0.39****
(0.06)
4.63*
(2.60)
0.68
220
1986; January 1989; March 1990; August 1993; and July 1994) are associated with
increases in the money supply.
As with the fiscal regressions I calculated the conditional effects of elections
separately based on Model 1, which are shown in Table 5. As predicted, there are
monetary electoral cycles under flexible exchange rate regimes, but not under fixed

Table 5 Conditional effects of
elections on monetary policy in
Brazil
17
Central Bank
Independent
Conditional coefficients and
conditional standard errors are
calculated from model 1
Dependent
Exchange rates
Floating
Fixed
0.07
(0.78)
2.83**
(1.28)
0.03
(0.88)
0.29
(1.08)
or crawling peg regimes. The money supply is likely to increase by 2.83 percentage
points in election periods under a floating exchange rate regime when the central
bank is not independent. Unlike eastern European Union accession countries where
independent central banks tighten the money supply in election years (Hallerberg et
al. 2002), there is no evidence to suggest that an independent Brazilian central bank
behaves similarly. Rather, the regression results indicate that under floating regimes
and an independent central bank, there is no monetary cycle in Brazil, which is more
consistent with the original theory developed by Clark and Hallerberg (2000).
Indeed, the results of both monetary and fiscal policies in Brazil remarkably
resemble those of OECD countries.
Conclusion
The purpose of this article is to provide a more nuanced analysis of the effects of
exchange rate regimes on the existence or absence of opportunistic political business
cycles than has been done in cross-national studies. Earlier research on opportunistic
political business cycles in Latin America had mixed results, some finding
confirmatory evidence and others finding lack of conclusive evidence. Thus, an
important question remains as to whether Latin American politicians use
macroeconomic policies to boost their electoral chances as their counterparts in
OECD countries do. Is the lack of consistent evidence in Latin America due to the
possibility that the theory simply does not travel to developing countries, or is it
because of the imprecise measurement of key variables and lack of attention to the
countries peculiarities often not accounted for in large cross-national studies?
Using Clark and Hallerbergs (2000) theory based on the MundellFleming
model, this article analyzes electorally motivated fiscal and monetary cycles in
Brazil, while paying particular attention to the actual behavior of economic
institutions and their variations over time. The theory predicted that under mobile
capital fiscal cycles should be present under fixed exchange rates but absent under
flexible exchange rates. Conversely, monetary cycles should be present under
flexible exchange rates, but only when the central bank is dependent. The empirical
analyses takes into account various economic stabilization programs, currency
changes, and both statutory status and actual behavior of the central bank and
exchange rate regimes, and uses disaggregated data to analyze the hypotheses. The
evidence provides strong support for the theory in the Brazilian experience. There
are fiscal cycles when the exchange rate is fixed or a crawling peg, and there are
monetary cycles only when the central bank is dependent and the exchange rate is
18
flexible but not at other times. Thus, this study shows that when the peculiarities of
and longitudinal differences within the country were accounted for in the data
analyses, Brazils fiscal and monetary policy behavior resembled remarkably the
behavior observed in more affluent, economically stable OECD countries. Although
prior research of political business cycles in Latin America has generally yielded
inconclusive results, the findings of this study suggest that Latin American
politicians are also likely to use macroeconomic policy instruments opportunistically
just like their OECD country counterparts. Yet it also shows that research in this area
would require precise model specifications as well as close attention to the deeds of
economic institutions.
Interestingly, Brazils monetary behavior under an independent central bank
differed from that observed in eastern European Union accession countries. In the
latter, there was a monetary contraction under floating exchange rates and an
independent central bank (Hallerberg et al. 2002). In Brazil, there was no such
behavior. These differences may be explained in terms of their differential positions
in their respective regions. Hallerberg et al. (2002) speculated that those eastern
European countries were signaling to the markets central bank independence by
adopting contractionary monetary policies precisely when the opposite would be
expected under dependent central banks. Indeed, these countries had to prove their
commitments to central bank independence to the European Union where central
bank independence is of paramount value. In other words, they are norm followers.
Brazils position in South America is different. Brazil is a leader and a norm-setter in the
South American region (Genna and Hiroi 2005, 2007), and therefore need not prove
the independence of its central bank by engaging in similar behavior. Yet other Latin
American countries may exhibit patterns similar to eastern European countries.
Acknowledgements This research was originally developed with Mark Hallerberg as a collaborative
project, funded by the Center for Latin American Studies at the University of Pittsburgh. I am grateful to
Mark Hallerberg, Gaspare Genna, and anonymous reviewers for insightful comments. As usual I am solely
responsible for any errors. Earlier versions of the article were presented at the annual meetings of the Latin
American Studies Association and International Studies Association.
Appendix 1
Table 6 Variable definitions and sources
Variable
Sources
Budget Balance
Banco Central do Brasil,

Monthly cash balance of the National
online database (www.bcb.gov.br).
Treasury (Execuo Financeira do
Tesouro Nacional (Fluxos)Resultado
de Caixa), converted into the real
(current currency unit) using BCBs
Multiplicador de Unificao Monetria.
The variable was transformed into %
of monthly GDP.
Monthly M1 (working day balance
average), converted into the real
using BCBs Multiplicador de
Unificao Monetria.
Money Supply (M1)
Coding and definition
19
Table 6 (continued)
Variable
Sources
Coding and definition
Election
Tribunal Superior Eleitoral.
Presidential and legislative elections.

Coded 1 for the election month and
11 preceding months; 0 otherwise.
Fixed and pegged exchange rates are
coded 1; 0 if floating.
Fixed/Pegged Exchange
Rates
Banco Central do Brasil;

Bonomo and Terra (2001);
Levy-Yeyati and Sturzenegger
(2003; Levy-Yeyati 2005).
Central Bank
Authors interviews with
Independence
central bankers, Ministry
of Finance officials, and other
government and congressional
staff. Various news reports.
Holanda and Freire (2002).
Stabilization Programs
Banco Central do Brasil;
(Cruzado, Bresser, Rice Baer and Paiva (1998).
and Beans, Summer,
Collor I, Collor II,
Immediate Action,
and Real)
GDP Growth
Interest Rate
Inflation Rate
Currency Change
Coded 1 if the central bank is

independent; 0 if not independent.
For each stabilization program

coded 1 if the stabilization program is
in force. See Table 2 for details. The
reference category is no stabilization
program in force.
Annual real GDP growth rate.
Annual interest rate in each month.

The rates are the central banks nominal
(annualized) interest rates known as the
taxa Selic. Interest rates are transformed
into the natural logarithm scale due
to the datas skewness.
Monthly inflation rate (ndice nacional
de preos ao consumidor-INPC).
Banco Central do Brasil.
Coded 1 for the month in which
there was a currency change;
0 otherwise.
Appendix 2
Table 7 Reestimation of regression models
Fiscal
regression
Monetary
regression
CBI
0.37
(0.85)
1.08
(0.75)
Election CBI
Election crawling peg
1.77
(1.15)
2.60**
(1.24)
0.41
(1.20)
0.17
(0.67)
2.53*
(1.47)
2.26
(1.54)
1.97
(1.90)
Election
Crawling peg
CBI crawling peg
20
Table 7 (continued)
Election CBI crawling peg

Conditional coefficient
Election under crawling peg regime
Election under crawling peg regime and independent Central Bank
Election under flexible regime
Election under flexible regime and independent Central Bank
Fiscal
regression
Monetary
regression
2.16
(1.91)
1.40
(0.79)*
0.34
(1.05)
0.03
(0.85)
2.60**
(1.24)
2.53*
(1.47)
0.63
(0.39)
0.12***
(0.04)
11.36****
(1.63)
0.02
(0.11)
0.37
(0.85)
Monthly inflation rate
0.13
(0.16)
Currency change
GDP growth
0.27**
(0.12)
0.62****
(0.08)
0.20***
(0.07)
Monthly budget balance as % of GDP (t1)

Change in monthly budget balance as % of GDP (t1)
Monthly change in the seasonally adjusted M1 (t1)
Constant
2
Adjusted R
N
0.49
(0.65)
0.36
237
0.44****
(0.05)
1.90
(1.33)
0.71
227
Due to limited space, coefficients for various stabilization programs are not shown, but the models were
estimated with them. Entries are unstandardized coefficients. Entries in parentheses are standard errors
****p0.001; ***p0.01; **p0.05; *p0.1 (two-tailed test)
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Taeko Hiroi is assistant professor of political science at The University of Texas at El Paso. Her research
focuses on political institutions and political economy in Latin America. Her most recent publications
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Studies.

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