According to economic academics, one of the causes of inflation in Brazil was the inertial inflation phenomenon. Prices were adjusted on a daily basis according to changes in price indices and to the exchange rate of the local currency to the U.S. dollar. Plano Real then created a non-monetary currency, the Unidade Real de Valor, whose value was set to approximately 1 US dollar. All prices were quoted in these two currencies, cruzeiro real and URV, but payments had to be made exclusively in cruzeiros reais. Prices quoted in URV did not change over time, while their equivalent in cruzeiros reals increased nominally every day.
Solution
The Plano Real intended to stabilize the domestic currency in nominal terms after a string of failed plans to control inflation. It created the Unidade Real de Valor, which served as a key step to the implementation of the new currency, the real. At first, most academics tended not to believe that the Plan could succeed. Stephen Kanitz was the first public intellectual to predict the future success of the Real Plan. A new currency called the real was introduced on 1 July 1994, as part of a broader plan to stabilize the Brazilian economy, substituting the short-lived cruzeiro real in the process. Then, a series of contracting fiscal and monetary policies was enacted, restricting the government expenses and raising interest rates. By doing so, the country was able to keep inflation under control for several years. In addition, high interest rates attracted enough foreign capital to finance the current account deficit and increased the country's international reserves. The government put a strong focus on the management of the balance of payments, at first by setting the real at a very high value relative to the U.S. dollar, and later by a sharp increase on domestic interest rates to maintain a positive influx of foreign capitals to local currency bond markets, financing Brazilian expenditures.
Result
The real initially appreciated against the U.S. dollar as a result of large capital inflows in late 1994 and 1995. It then began a gradual depreciation process, culminating in the 1999 January currency crisis, when the real suffered a maxi-devaluation, and fluctuated wildly. Following this period of a quasi-fixed exchange rate, an inflation-targeting policy was instituted by new central bank president Arminio Fraga, which effectively meant that the fixed-exchange period was over. However, the currency was never truly "free", being more accurately described as a managed or "dirty" float, with frequent central bank interventions to manipulate its dollar price. The currency's appreciation was crucial to keep inflation under control. Mainly, it assured the supply of cheap imported products to meet the domestic demand and forced domestic producers to sell at lower prices in order to maintain their market shares. This was especially important in the period immediately following the adoption of the new currency, when the sudden drop in inflation caused a surge in demand. The increased imports, therefore, were essential to avoid demand-side inflationary pressures that would undermine the stabilization plan.
