Hyperinflation in Venezuela
Over the past few decades, the rate of hyperinflation in the globe has reduced significantly, but still poses a considerable challenge to some western countries and those located in Africa. Hyperinflation is an economic condition characterized by rapid, debilitating inflation that leads to a significant devaluation of a country’s currency (Moosa 123). Marta adds that according to the post-Keynesian framework, hyperinflation indicates the loss of the central bank’s ability to conduct monetary policy, leading to rejection of national currency and dollarization of the economy (2). Hanke also empathizes that hyperinflation is exhibited by an inflation rate that exceeds 50% per month.
Among nations that have significantly been affected by hyperinflation in the most recent years include Bulgaria, Zimbabwe, not to mention Venezuela, the primary focus of this research. While inflation was prevalent in Venezuela since the 90s, the country experienced amongst its greatest episodes of hyperinflation in 2016 (Hanke). The phenomenon largely disrupted businesses, not to mention the magnitude of damage caused to the country’s economy. Given the adversities associated with the condition, research is required to identify policies that led to hyperinflation and how the government could have avoided it, to provide significant lessons to countries that are likely to face a similar situation.
Research Question: What government policies led to the hyperinflation? And how could they have avoided it?
While Venezuela is the primary focus of this research, it is undeniable that some few other countries have in the past experienced or are at the risk of facing hyperinflation. For instance, Brazil is an example of nations that have endured a prolonged period of hyperinflation and implemented measures to curb the crisis. Therefore, the selected research question is very critical as it exemplifies an uncommon economic condition that has had adverse repercussions on Venezuela and the potential to affect other countries of the globe. The research also analyzes ways in which similar economic disasters can be avoided in other countries in the future.
Dynamics of the Hyperinflation
The dynamics of hyperinflation entail all elements that contribute to the extremely high rate of inflation. Economists theorize that the equation of exchange adequately addresses the forces that stimulate inflation (Welch and Welch G 231). Notably, the elements in the equation of exchange are supply of money, velocity of money, level of prices, and the actual output of goods and services denoted by letters M, V, P, and Q, respectively. As such, the simple equation of exchange appears as follows: MV=PQ. According to scholars, a rise in money supply in the equation of exchange causes an increase in the velocity of money, and consequently, intensification in the price level or inflation (Welch and Welch G 231). The changes may mainly occur in a scenario where the economy is at full employment, such that further increase in the money supply can no longer enhance the level of gross domestic product. Instead, the additional supply of money affects price levels, which leads to an uncontrollable level of inflation.
The other dynamic of hyperinflation is its cycle and incubation period. Scholars observe that, on average, the incubation period of hyperinflation is 8-9 years, with a relatively short explosive phase of 2-3 years (Saboin-Garcia 12). The implication of this is that it may take years before the elements of hyperinflation are noticeable in a country. However, when this happens, the uncontainable level of inflation can drastically affect the economy, from the devaluation of the currency to skyrocketing prices of goods and services.
Causes of Hyperinflation in Venezuela in 2016
Research suggests that hyperinflation in Venezuela was triggered by a combination of external factors and poor government policies. Marta (24) argues that the plummeting oil prices were a potential cause of Venezuela’s struggle with double-digit inflation, as shown in figure 1. Notably, Venezuela has, for decades, exhibited an extremely high dependency on oil. Studies reveal that by 2015, 96% of the country’s exports and 60% of government revenues relied on the oil industry (Mu and Hu 200). Thus, the incredible dependency on the sector likely affected Venezuela’s economic performance when the oil prices fell in 2014. In particular, the decline in oil prices translated into a shrinkage in Venezuela’s Gross Domestic Product as the country’s actual output of goods and services (Q), as denoted in the equation of exchange, was highly dependent on the industry. Arguably, had the government diversified its investment in other sectors, the adverse effects of plummeting oil prices on inflation may have been avoided.
Brent Crude Oil Price and Venezuela GDP
Source: IMF, BP Statistic 2016
As can be seen in figure 1, the Brent crude oil price declined significantly from 100USD/bbl in 2012 to approximately 50USD/bbl in 2014 in the global market. Given that Venezuela’s economic performance relies on the oil industry, the GDP also declined during this period. The effect of plummeting oil prices in 2014 is hypothesized to have been transmitted to 2016, fueling hyperinflation in the country.
Research also suggests that poor government policies triggered hyperinflation in Venezuela in 2016. Notably, Lampa (11) observes that in 2012, Venezuela’s government loosened its strict controls on capital and imports and increased regulation of the currency market in preparation for the 2012 presidential elections. The relaxed restriction on capital may have fostered capital flight and consequently triggered inflation in 2016. According to scholars, capital flight refers to the movement of money out of a domestic economy to another country’s economy (Nelson et al 41). In light of this, capital flight may have lowered the availability of capital required for the development of the country’s economy in 2016, resulting in a decline in GDP.
Studies further reveal that poor government decisions were made in devaluing the domestic currency, a move that fueled the 2016 hyperinflation. As observed by Marta (25), the Venezuela authority devalued the bolivar in February 2013, from 4.3 to 6.3 BsF/4$. Based on economic principles, devaluation of the current was a probable cause of problems in the balance of payment, as exports increased while imports became more expensive to domestic consumers. Furthermore, research shows that Venezuela relies heavily on imports for inputs of production (Marta 26). Therefore, as imports became more expensive, the GDP contracted, the prices of domestic goods increased, and inflation rose, as shown in figure 2.
As can be seen in Figure 2, the devaluation of the bolivar in 2012 had a significant implication on the balance of payment and inflation rate. Notably, increased prices of imports and a reduction in GDP resulted in an inflation rate of 720% in 2016. Arguably, the out-of-control rise of inflation may have been caused by different measures by the government and business firms. In particular, it is observed that during this period, the firms set prices higher as if the domestic currency was weaker than the official exchange rate, which was not the case. Therefore, as the supply of money increased in 2012, in the face of the devaluation of the currency, the price levels rose significantly in 2013 and subsequent years, reaching astronomical levels by 2016.
Mechanism Behind the Hyperinflation
The mechanism behind the hyperinflation in Venezuela can be explained in different ways depending on each cause identified in the research, among them the plummeting price of oil experienced in 2014. Notably, as the price of oil in the global market declined in 2014, Venezuela’s GDP was significantly affected as the country relied heavily on revenue generated from the industry. However, apart from the declining oil prices, other underlying factors further triggered the shrinkage of the economy. Earlier in 2015, Venezuela’s central bank had purchased bonds issued by the state-owned oil company, PDVSA, in adherence to a law passed in 2009 (Marta 28). Based on the mechanisms of the monetary policy, it is probable that the open-market operation, purchase of bonds, increased supply of money in the economy and lowered interest rates, as shown in figure 3. Reduced GDP, as a result of plummeting oil prices, coupled with the increased money circulation in the economy, may have been a probable cause of hyperinflation and instability of the domestic currency.
Figure 3 illustrates the effects of Open Market Operations on Money Supply. Notably, the move by the central banks to purchase bonds increased money supply in the economy from M1 to M2. The expansionary monetary policy likely triggered inflation as the money supply exceeded the amount of money demanded to keep the economy stable.
The second mechanism of inflation was based on the government’s decision to devalue the domestic currency and loosen its strict control of the capital. Notably, as the government deregulated capital control, the economy experienced a capital flight. Limited money was available in the economy to facilitate the production of goods and services that constituted the GDP. Additionally, a further devaluation of the currency made imports more expensive and costs of production high, which translated to higher prices for domestic goods. With the changes in foreign exchange rationing, the GDP continued to shrink, and the rate of inflation accelerated to uncontrollable limits.
Government Measures to Control the Hyperinflation
Hyperinflation and instability of the domestic currency remain a significant crisis in Venezuela to date despite the government’s attempt to introduce economic measures. One of the most substantial economic reforms made in the country was the introduction of a new currency. Notably, the government, through the central bank, issued parallel currency, Petro, in 2018 to try and reduce hyperinflation (“Drastic New Measures”). The new currency is tied to the price of oil and is expected to help stop hyperinflation by reducing the number of Bolivars required in exchange for a dollar. For instance, 1 Petro is worth 60 dollars and 3,6000 sovereign bolivars (“Drastic New Measures”). So far, these measures have not been successful, as the IMF continues to forecast further deterioration of the hyperinflation. Perhaps, the lack of adequate foreign reserves to circulate in the economy could be among the reasons why the measure has been unsuccessful.
Effects of Hyperinflation on Economy
Apart from the hyperinflation prevailing in recent years, the country’s economy remains at the recession since 2016. When the hyperinflation occurred, Venezuela’s GDP dropped to -3.4% in 2016 (Marta 25). The statistic, as reported by IMF, was an indication that the economy had undergone a drastic contraction. During this period, the country’s national debt increased, and the unemployment rate remained high. In the most recent years, the country’s GDP continues to decline further, from 324 billion dollars in 2015 to 143 billion dollars in 2017, with the financial forecasts showing an additional contraction of nearly 83% in the next few years (Plecher). An article by the New York Times also reveals that in 2020, Venezuela’s gross domestic product will lose an additional 10% (Kurmanaev and Herrera). The data is an indication that despite the economic reforms being made by the government, Venezuela’s economy is yet to enter the recovery stage of the economic cycle.
Comparison to Brazil
The ongoing hyperinflation in Venezuela compares to the out-of-control inflation experienced in Brazil in the early 1990s. Some scholars argue that the primary cause of inflation was the high debt that the country owed foreigners (Allen 211). As a result, a significant fraction of the capital was transferred outside the country, limiting the amount of capital available for domestic investment. Other scholars argue that hyperinflation was caused by excessive growth of money as a result of high budget deficits, oil and exchange rate shocks experienced earlier in the country, and the heavy reliance of the Central bank on the government (Tullio and Ronci 635). From this perspective, it is probable that the Central bank’s decision to buy short term bonds in a period of economic recession triggered additional money circulation, causing an immediate inflation effect. Despite the varying views among scholars, all research shows that hyperinflation was triggered by external factors, such as changes in oil prices in the global market, and internal developments such as excessive growth of money in the country, which destabilized the domestic currency.
Attempts to Stabilize the Economy
So far, Venezuela’s government has made a few attempts to stabilize the economy, including deregulating the private sector. For years, the socialist government in Venezuela has been stringent on regulating the private sector and capitalizing more on nationalizing businesses. Likely, such actions greatly led to a clash between the country’s politics and economics, as the government was more inclined to nationalizing businesses and restricting private investments. However, the authorities recently let loose of some of these regulations, allowing the private sector to reinvest in the economy (Kurmanaev and Herrera). Research shows that while this measure has provided marginal relief, it is yet to stabilize the country’s economy adequately.
Lessons from Policy
While Venezuela’s policies are yet to yield a considerable effect on the state as a whole, they serve as a significant lesson to countries that face potential exposure to hyperinflation. Notably, the existing policies exemplify the benefits of lifting stringent control over the private sector. Today, Venezuela’s economy exhibits some signs of recovery partly because of reduced regulation of the private sector. Similarly, other countries can use this lesson to promote both the public and private sectors, which play a significant role in stabilizing the economy. Governments should also avoid relying heavily on one industry where opportunities exist to invest in other areas that strengthen the GDP.
Based on the ongoing global pandemic and economic measures being taken by governments, some countries that are currently facing significant inflation rates may eventually experience hyperinflation. In my opinion, this may be caused by the massive amount of Covid-19 stimulus being injected in economies. If governments fail to strike a balance between the inflationary forces of the stimulus and existing GDP, some countries may eventually experience inflation or even hyperinflation in the worst-case scenarios.
The ongoing hyperinflation in Venezuela is the worst that the country has experienced in years. Findings from the research show that the leading causes of the hyperinflation are poor government policies and tripling effect of plummeting oil prices in prior years. The government has been making economic reforms to stop the hyperinflation and stabilize the economy, such as loosening control over the private sector and introducing a new currency. However, they are yet to yield the anticipated effect, likely because some measures are still premature. For this reason, further follow-up research is required to establish the outcomes of the measures in the next few years.
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