[FREE] Suppose the Brazilian government recognizes that its reliance on coffee exports makes it vulnerable to the - brainly.com (2025)

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The Brazilian government has created a currency stabilization fund to maintain a stable exchange rate and prevent negative outcomes caused by fluctuations in coffee prices. The fund managers intervene by purchasing excess supply of reais in the international exchange market when the real depreciates below a predetermined threshold value, increasing the value of the real to at least the floor value set by the government.

Explanation

The Brazilian government has taken proactive measures to stabilize the value of its currency, the Brazilian real, due to the vulnerability caused by heavy reliance on coffee exports. To achieve this, the government has created a currency stabilization fund. This fund aims to maintain a stable exchange rate and prevent negative outcomes caused by fluctuations in coffee prices, a phenomenon known as the Dutch Disease.

Within this stabilization fund, the fund managers have specific actions to stabilize the value of the Brazilian real within a certain range. One of these actions is triggered when the real depreciates below a predetermined threshold value, also known as a floor. In such a scenario, the fund managers intervene by purchasing the excess supply of reais in the international exchange market. By doing so, they increase the value of the real to at least the floor value set by the government.

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The Brazilian government has established a currency stabilization fund to protect the real from fluctuations in coffee prices, managing its exchange rate against Dutch Disease. The fund intervenes in the market by buying reais when their value drops below a certain threshold. This action helps maintain a stable exchange rate, benefiting Brazil's economy by ensuring exports remain competitive.

Explanation

The Brazilian government recognizes the risks associated with its heavy reliance on coffee exports, which makes the country vulnerable to Dutch Disease. Dutch Disease occurs when an increase in revenues from natural resources or exports leads to a decrease in the competitiveness of other sectors in the economy due to currency appreciation.

To manage this risk, Brazil has established a currency stabilization fund. The primary objective of this fund is to maintain a stable exchange rate for the Brazilian real to shield the economy from volatile coffee prices.

  1. When Coffee Prices Increase:

    • The value of the Brazilian real appreciates, making exports more expensive for foreign buyers.
    • This could lead to a decline in demand for Brazilian exports in other sectors, which can harm the overall economy.
  2. When Coffee Prices Fall:

    • The Brazilian real depreciates, leading to a decline in government revenues and impacting economic growth negatively.

To combat these fluctuations, the currency stabilization fund intervenes in the foreign exchange market. Specifically, if the real falls below a targeted threshold (or floor) value, fund managers will purchase excess reais from the market. This action increases the demand for the real, ultimately raising its value back to the floor level set by the government. This mechanism is critical to provide stability in foreign exchange rates, thus protecting Brazil's economy from sudden shifts that could arise from changes in coffee export revenues.

Examples & Evidence

An example of this mechanism in action could be observed if coffee prices greatly increased, leading to a stronger real. The government might have to step in to prevent excessive appreciation, ensuring that other industries can still compete in international markets. Conversely, if coffee prices drop, the fund would buy reais to prevent significant depreciation and resultant economic impacts.

The existence of currency stabilization funds and their role in managing exchange rates can be found in economic literature and case studies regarding countries that are heavily reliant on commodity exports, including Brazil. Empirical evidence from these studies demonstrates that such funds can effectively mitigate the risks associated with volatile currency values.

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