President Franklin Delano Roosevelt was elected in October 1932, in the midst of the Great Depression. High unemployment, severely depressed spending, and double-digit deflation plagued the economy. Shortly after his inauguration in March 1933, a dramatic turnaround occurred. Positive inflation was restored, and 1933 to 1937 was the fastest four-year period of output growth in peacetime in United States history.
How did such a transformation occur? Economists Peter Temin and Barrie Wigmore attribute the recovery to a “regime change.” In the economics literature, regime change refers to the idea that a set of new policies can have major effects by rapidly and sharply changing expectations. A regime change can occur when a policymaker credibly commits to a new set of policies and goals. Gauti Eggertsson, who also analyzes the regime change under Roosevelt, explains:
“On the monetary policy side, FDR abolished the gold standard and — even more importantly — announced an explicit policy objective of inflating the price level to pre-depression levels. On the fiscal policy side, FDR expanded government real and deficit spending (i.e. government credit expansion) which made his policy objective credible. The key to the recovery was the successful management of expectations about future policy…
Coordinated monetary and fiscal policy ended the Great Depression by engineering a shift in expectations from “contractionary,” i.e. the private sector expected future economic contraction and deflation, to “expansionary,” i.e. the public expected future economic expansion and inflation. The expectation of higher future inflation lowered the real rate of interest, thus stimulating demand, while the expectation of higher future income stimulated demand by raising permanent income.”
In short, Roosevelt stated and proved that he was willing to do whatever it would take to end deflation and restore economic growth. As Roosevelt proclaimed on October 22, 1933: “If we cannot do this one way, we will do it another. Do it, we will.”
Almost all politicians promise change but few manage such drastic transformation. In Brazil’s closely contested presidential election this October, incumbent President Dilma Rousseff won reelection with a three-point margin over centrist candidate Aecio Neves. Rouseff told supporters, “I know that I am being sent back to the presidency to make the big changes that Brazilian society demands. I want to be a much better president than I have been until now.”
Rousseff’s rhetoric of “big changes” refers in large part to the Brazilian economy, which is plagued with stagnant growth, high inflation, and a strained federal budget. Brazil’s currency, the real, hit a nine-year low following Rousseff’s victory, and the stock market also tumbled. This market tumult reflects investors’ doubts about the Rousseff administration’s intention and ability to enact effective reforms. Investors viewed Neves as the pro-business, anti-interventionist candidate and are unconvinced that Rousseff will act decisively to restore fiscal discipline and rein in inflation. In other words, Rousseff’s talk of change is not fully credible in the way that Roosevelt’s was.
Since winning reelection, Rousseff has begun to implement some of the same policy reforms that Neves proposed. For instance, fuel prices were allowed to rise, as a step toward ending fuel price controls. Rousseff has also begun to reduce state bank subsidized lending. The central bank, which lacks complete autonomy from the government, finally raised its benchmark interest rate by 25 basis points in response to above-target inflation and has signaled that further rate hikes could ensue.
Though Rousseff is taking some actions to improve business conditions, restore fiscal discipline, and reduce inflation, the problem is that they are being enacted quietly and reluctantly rather than being trumpeted as part of a broader vision of reform. The key to regime change is that the effects of policy changes depend crucially on how the changes are presented and perceived. Economic policies work not only through direct channels but also through signaling and expectations. For example, a small rise in fuel prices and a reduction in state bank subsidized lending may have small direct effects, but if they are viewed as signals that the president is wholeheartedly embracing market-friendly reforms, the effects will be much greater. So far, despite Rousseff’s campaign slogan — “new government, new ideas” — she hasn’t credibly committed to a new regime.
One way she might attempt to signal real commitment to regime change is through the appointment of new members to her administration. Upon resignation, Marta Suplicy, Rousseff’s culture minister since 2012, urged President Rousseff to set up “an independent economic team, with proven experience, to rescue the credibility of [her] government.” Most notably, Rousseff will be replacing Finance Minister Guido Mantega. She is expected to choose banker and University of Chicago-trained economist Joaquim Levy as Mantega’s replacement. As Brazil’s treasury chief from 2003 to 2006, Levy proved himself a fiscal hawk and helped Brazil restore its investment grade rating.
Levy’s fiscal conservatism and economic orthodoxy appeals to investors; markets rose at the news of his probable appointment. However, members of President Rousseff’s Workers’ Party, and Rousseff herself, are likely to oppose aspects of his approach. Rousseff received her strongest electoral support from the poorest parts of the country. In the short run at least, her pledges to fight poverty and inequality will be in tension with tighter fiscal and monetary policy. Unless Levy’s economic reforms can preserve popular anti-poverty programs, Rousseff is unlikely to follow through. So far, Rousseff’s “new government, new ideas” has not translated into a new regime.
Carola Binder is a Ph.D. candidate in the Department of Economics at UC Berkeley.