This case study will address the concept of inflation – the rise in average level of prices sustained over time that corresponds to a fall in the internal (domestic) purchasing power of money – with regards to Venezuela. The goal here is to explore several trains of enquiry in order to critically evaluate the impact inflation has had – and may potentially have – on the national income and economic growth of Venezuela. As it stands, Venezuela’s inflation rate – 282972.8% – significantly exceeds that which holds 2nd position – Zimbabwe -175.66% (WorldEconomicForum 2019). In order to better decipher the notable disparity in inflation rates between Venezuela and the rest of the world, several areas will be analysed. This macroeconomic issue will be addressed with regards to challenges surrounding it alongside any potential benefits, it’s impact on the labour market, it’s fiscal impact in terms of taxes and government spending and potential policies that could be implemented in hope of combating it.
Venezuela holds the highest recorded oil reserves in the world – possessing approximately 300 billion barrels – even surpassing Saudi Arabia. Evidently, oil is one of Venezuela’s most valuable commodities accounting for 95% of Venezuela’s exports and 25% of its gross domestic product (Independent 2018). However, during a period of time in which the global price of oil dropped, foreign demand to buy Venezuelan oil dipped simultaneously.
A key factor that lead to Venezuela’s current crisis, is evidently their sole dependence on a single commodity – oil. As University of Florida’s Gamarra explains, this means “you are bound to the ups and downs of the oil price,”. Without a range of high value added assets, an economy lacks diversity and is vulnerable to ‘moments of downturns in your principal commodities (CNBC 2019).’ On an individual basis, hyperinflation renders any savings worthless due to its eroding impact on money. Consequently, people may hoard goods for instance, food due to the soaring prices. Situations such as these may lead to shortages of food supply, contributing to the issue further.
The Bolívar (Venuzuelan currency) depreciated in value as the cost of imports increased, leaving the Venezuelan economy to perish. Consequently, Nicolas Maduro – Venezuela’s new president – decided to print money (TheConversation 2019). Although this is an efficient strategy to implement during times of temporary price shock, in the case of Venezuela, the desired results didn’t adhere. Alongside the price of oil continuing to decrease, Venezuela’s oil output also fell resulting in international investors looking elsewhere further decreasing the value of the Bolívar. The government proceeded to print off more money in order to pay their expenses, inevitably resulting in the cycle that lead to hyperinflation (TheConversation 2019).
To begin with, whether or not inflation is always deemed to be a challenge or if there are actually any potential benefits surrounding the macroeconomic issue will be discussed. Generally speaking, moderate inflation has some benefits, especially when it’s compared to deflation. For instance, the real value of debt decreases, moderate rates also enable prices of goods to adjust to their real value prices. In some cases, at levels of moderate inflation, companies are able to increase wages whilst the prices of goods increases.
However, the average inflation target is usually around 2% which is quite contrasting to that of Venezuela’s. Long term economic growth is thought to be optimised when price stability is maintained, which is done by controlling inflation (Investopedia 2019). At the level of inflation currently being faced by Venezuela, it is more suitable to refer to it as hyperinflation – a more extreme inflation during which price increases are uncontrollable and the value of money erodes to the extent that it is rendered worthless (thebalance 2019). Under these circumstances, few people benefit, however, debt holders and individuals who had taken out loans are amongst those who do, as inflation has the effect of eroding debt. Depending on the spread and severity of the inflation, the increase in prices make a debt worthless by comparison, under hyperinflation conditions, it’s virtually eliminated. Therefore, they find themselves able to pay back loans with ease and worthless money. Venezuela’s national debt had risen to approximately $156 billion in 2018 suggesting that they’d benefit from this immensely (MarketsInsider 2019). Similarly, those who are involved in the commodities export businesses are also at advantage. The decrease in value of a local currency results in cheaper exports in comparison to those of an exporter’s foreign competitors, at the same time, hard foreign currency is obtained (thebalance 2019) by the exporter.
Individuals who had however, lent money as opposed to loaned it, are likely to be most negatively impacted due to their money becoming worthless. Understandably, the negatives associated with inflation with regards to Venezuela considerably outweigh any benefits.
As of January 2020, Maduro initiated an increase in the national minimum wage. The minimum monthly salary earner is currently receiving 250,000 bolivars (£2.80) , a 67% increase from the previous minimum wage – 150,000 bolivars. Alongside this, he implemented a food bonus of 200,000 bolivars (Quartz 2020) – that goes for individuals who are actually employed. It was predicted that Venezuela’s unemployment rate would have reached 50% by this year..
Venezuela’s unemployment rate – referring to the segment of the labour force actively seeking and able to undergo employment, without work – was forecasted to be 44.337% during the December period of 2019. An almost 10% increase since the year prior illustrating the apparent negative impact inflation has on employment (CEIC 2019). In the short term, individuals are likely to supply labour despite the acceleration in inflation due to the higher wages.
According to the Phillips curve, inflation and unemployment maintain an inverse relationship meaning low levels of unemployment correspond to higher levels of inflation and high unemployment corresponds to lower levels of inflation – potentially deflation. Logically, this makes sense as high unemployment would put a downward pressure on prices of goods and reduce inflation. This is because a lack of income makes excess expenditure less permissive. However, in the case of Venezuela, it differs. Venezuela is undergoing extremely high inflation as well as relatively high unemployment rates.
When unemployment is high, the supply for labour is traditionally greater than the demand for it, as the number of individuals seeking work significantly exceeds the number of jobs available. Therefore, increasing wages as a means of employers bidding for the service of employees is unnecessary – and so wages remain stagnant during inflation periods.
As Venezuela demonstrates, an economy can encounter high inflation alongside low economic growth at one time. Several technical explanations can be proposed with regards to why the country’s economic growth is in deficit. A primary one being the concept of demand-pull inflation which comes about as a result of the demand for goods surpassing the supply available. However, no fundamental increase in aggregate demand was displayed in the case of Venezuela. Instead, the supply fell considerably short. The lack of foreign currency reserves lead to the inability to import fundamental commodities beyond a particular point causing a demand-pull inflation.
What’s more, producers increased the prices of their goods and services in order to relay the increased production costs. This is referred to as cost-pull inflation. The lack of ability to secure imports in Venezuela contributed to the rise in production costs. This played a role in the further hindrance of Venezuela’s domestic production (Profolus 2018).
Under Maduro’s regulation, the money supply and minimum wage were increased, in attempt to manage consumer spending capabilities, as already discussed. The monetary explanation – is partially applicable when trying to understand the causes of Venezuela’s hyperinflation and it states that the idea of excess money supply with the same amount of goods leads to the decrease in value of a currency.
The current state of Venezuela, demonstrates the profligacy exhibited that lead to fiscal dominance of monetary policy. In attempt to diminish the gap between spending and revenue, a government may decide to fund expenditures via tax revenues – bonds that are to be paid back through future tax revenues or through central bank seigniorage – could be implemented. Seigniorage reliance from the government is likely to govern a lack of incline to continue using a currency which is losing value. Part of the seigniorage serves a purpose as an inflation tax. The rate of inflation acts as a tax rate therefore an increasing rate of inflation would result in higher levels of revenue for the government. This however, is dependent on the public’s willingness to maintain real money balances as an increase in inflation means a decrease in money balances available for public holding – potentially limiting the revenue generated by the government. In essence, hyperinflation can potentially be perceived as a large scale taxation scheme.
During periods of inflation, the real purchasing power of tax revenues decline. Constant expenditures lead to a larger budget deficit as a result of the reductions in the real value of revenues. This tendency of inflation to increase the real budget deficit is referred to as the Tanzi effect. During hyperinflation, however, the Tanzi effect reduces the real value of tax revenues.
It’s deemed that so long as individuals remain confident in fiscal authorities and their ability to respond to inflation – via the means of increasing taxes or decreasing expenditures – they will hold money as a means of exchange and store of value. However, upon the emergence of the Tanzi effect, people’s confidence in the government’s ability to manage the deficit is disrupted, prompting them to reduce their holdings of real money balances (Niskanen Center 2018).
It’s apparent that the Venezuelan government spending is significantly exceeding that which it is taking in and therefore putting them in a budget deficit. The government ceased releasing statistics with regards to the magnitude of the country’s budget deficit a few years ago. Nevertheless, reducing it is deemed a prime concern. However the CIA have estimated that the deficit is approximately 46% of the countries gross domestic product during the period of 2017 (Bloomberg 2019). One approach in hope of restoring Venezuela’s previously satisfactory economy, is for them to loan a significantly large amount of money – $60 billion over the period of three years – to them. Theoretically, this would enable the central bank to terminate the printing of Bolívar’s. This would, in theory, diminish the on going decrease of the Bolívar’s value – which has lost 99% of its value since 2013 (Bloomberg 2019). Similarly, replacing the national currency all together with a more stable currency – such as the US dollar – would be of benefit.
Another commonly identified flaw that Venezuela is victim of, is their reliance upon a single and arguably unstable, commodity – being crude oil. As previously mentioned, the country would benefit immensely from expanding their number and range of export goods. Over the past decade, the difficulties associated with oil extraction and production have seemingly become more apparent. Not only this but the imposition of several sanctions on Venezuela’s oil industry, on behalf of the US, are significantly contributing to the industry’s downfall. The sanctions have meant that the US – one of Venezuela’s key oil associates – are blocked from doing business with Venezuela. They were implemented in hope of pressurising Venezuela’s President – Maduro – into stepping down. Presumably, the sanctions will stay in play until this is fulfilled, therefore broadening their commodities seems to be a favourable move.
Switching from the Bolívar to the U.S. dollar and acknowledging the underlying issue of their high dependence on a – somewhat undependable – commodity in conjunction with other credible government interventions will work best to maximise the potential stabilisation of Venezuela’s economy in years to come.