Since November 2017, Venezuela is going through a hyperinflationary cycle in which prices have suffered a cumulative growth of 7,391,434,575.3% (1). This was due to a continuous monetary expansion because of the financing of the recurring deficits for which the public sector (especially the state oil company PDVSA) has been registering, since operating expenses have grown faster compared to income, as a consequence of the latter being anchored to the value of the preferential exchange rate under a regime of exchange rate controls that had been in force in Venezuela since 2003 (Guerra & Vera, 2019).
The hyperinflationary outbreak has led to the fiscal accounts being adjusted. According to UCAB’s (Universidad Católica Andrés Bello, in Caracas-Venezuela) the Situation Report for the third quarter of 2020, public sector revenues in the third quarter of 2020 decreased by 1.2% of GDP compared to the previous year as a result of a sharp fall in tax revenues from oil due to the decline in prices, which are closer to the production costs of a barrel of oil in Venezuela, and also due to the fall in tax collection via Value Added Tax (VAT) as a result of the fall in domestic consumption and the declining purchasing power of tax collections due to lags and the hyperinflation (the Olvera-Tanzi effect) (2). At the same time, sector expenditures also suffered reductions compared to 2019, falling by 2% as part of GDP, due to reductions in the payment of wages and salaries to public administration workers and also in the payment of pensions, obtaining a deficit balance of 8.4% as part of GDP.
Venezuela has experienced negative economic growth since 2013 with an accumulated drop of 67.1% (3) motivated by the fall in domestic aggregate demand (depression in private consumption, dismantling of investment private sector, the collapse of public investment, and the low impact of public operating expenses on the revitalization of the economy), the collapse of oil activity, and the drop in imports of both raw materials and spare parts and goods and services for final consumption. The forecasts for the year 2021 are still pessimistic for the country as it is expected a decline of 7% (4) as the economy will continue in recessionary phase with inflation of at least four digits (5), and there are no clear signs of a change of direction in the economic policies of the Nicolás Maduro regime, but rather it is expected that there will be greater opacity in the management of public finances and the external financial assets of Venezuela, as well as the pressure of the international community on the Maduro regime given the results of the questioned and “illegitimate” parliamentary elections of December 6th, which ranges from restrictions on access to external financing and oil-free marketing (6).
As Reinhart and Savastano (2003) (7) indicate, fiscal factors are behind all modern hyperinflation and that major fiscal adjustments have been needed to end them. In the case of Venezuela, unlike the hyperinflationary processes that occurred in Argentina, Brazil, and Peru in the 1980s and 1990s which took about 15 years to develop, Venezuela took 34 consecutive years of high inflation to register at least 50% month-on-month growth in November 2017. In this context, the following analysis presents a brief discussion on some successful experiences of economic stabilization as a reference framework for Venezuela’s policymaking.
Economic Reform in Germany
At the end of the Second World War in June 1945, Germany was destroyed, and its territory divided into four zones occupied by the victors: the USA, the Soviet Union, France, and England. Because of the economic chaos, the United States proposed to launch a plan to recover the area under its control and that later spread to the rest of the country, except for the part dominated by the Soviets, who always opposed the plan, called the Plan for Liquidation of the Finances of the War and for the Economic Recovery. With the participation of American technicians from the Treasury Department, the plan was coordinated by Ludwing Erhard, in what was called the German miracle. From there the social market economy was born.
- Prohibition of the fiscal deficit: The government could not run a fiscal deficit. All expenses had to have a genuine source of financing. The debt would be issued only based on certain future income.
- Spending reduction: The government was empowered to terminate contracts that it could not pay and apply all measures conducive to monetary stability.
- Creation of a new currency: The German mark was instituted to replace the real mark, June 21, 1948, in a fixed relationship with the dollar.
- Establishment of a strict limit on the issuance of money.
- Elimination of exchange and price control: Control over a group of assets was only maintained for a short time. Private sector wages were released. All Nazi laws on price agreements and against hoarding were repealed.
Israel Stabilization Plan
As a result of fiscal deficits derived from armed conflicts, Israel suffered in the 1970s and 1980s from high rates of inflation. The inflation rate between 1980 and 1983 was between 100% and 140% per year and in mid-1984 it reached 500%. This required a stabilization program that was applied in July 1985. The economy was indexed although not completely, which avoided the redistributive effects of inflation but made people tolerate inflation.
The program had the following objectives (Bruno and Piterman, 1998): to quickly reduce inflation and improve the balance of payments, to create the conditions to restore the growth of the economy. Three anchors based on the reduction of the fiscal deficit were combined: Fixing the exchange rate and wages, and a goal was established for credit. With the reduction of the deficit, an attempt was made to stabilize the balance of payments and give credibility to the fixation of the exchange rate after the devaluation.
The multiple anchors were intended to lower inflation quickly. After the plan, inflation fell to less than 30% in 1986 and unemployment increased slightly. The program was supported with a US $ 7 billion loan. With the stabilization plan, a new currency was established, the new shekel.
Bolivia Stabilization Plan
Bolivia began to register high inflation rates since the beginning of the eighties and the situation became unmanageable between April 1984 and mid-1985 when the average inflation was 46%. The peak was observed in February 1985 when the inflation rate reached 182%. The central bank acted as a financier of the government in the face of the fall in the collection and the lack of income.
The lack of control was such that between 1978 and 1982 there were at least five presidents of the Republic due to the political crisis and six attempts at plans to stabilize the economy accompanied by seven presidents of the central bank. The country did not have international reserves and the payment of the debt represented 306% of exports in 1982. In that year the foreign exchange reserves were exhausted and the government implemented a dual exchange rate system that also failed.
Upon assuming a new government, the need to end hyperinflation and the instability that it caused became urgent (Morales, 1988). Thus, on July 29, 1985, Supreme Decree 21,060 was approved, which contained the essential guidelines of the economic plan, which was based on drastic measures to correct the fiscal deficit by raising the price of gasoline to bring the deficit to zero, the freezing of wages and public investment. Also, exchange rates were unified, and currency convertibility was established, they were liberated from the exchange and goods markets. The instrumental basis of the program was the stabilization of the exchange rate, for which a new currency was adopted: the boliviano. The government managed to postpone the payments of foreign debt, which meant relief for public finances. Hyperinflation ended in September 1985 after the implementation of the economic program.
The Plan Real of Brazil
After the failed attempts to stabilize the economy with the Cruzado Plan and the Cruzeiro Plan, inflation in Brazil increased, reaching 3,000% in 1993. The Itamar Franco government appointed Fernando Henrique Cardozo as Minister of Finance, who with a team of economists designed and applied the Plan Real.
The fundamental elements of the real plan (Cardozo, 2006) were the following: A significant fiscal adjustment when the Social Emergency Fund was created, through which the government-controlled 25% of the national budget without the approval of Congress, a new currency, the real, based on a stable exchange rate in relation to the dollar, which worked similar to a currency board. To give it credibility, the real was conceived as a strong currency and would gradually adjust against the dollar. When the plan was applied, inflation fell rapidly, the economy grew, and Brazil successfully withstood the Mexican crisis of 1996 and the Asian crisis of 1998.
Peru Stabilization Plan
During the eighties, Peru registered high inflation, which in 1990 became hyperinflation when it registered the variation of prices that year by 7.650%, while the activity decreased 6.5%. Between 1987 and 1990 the economy showed high inflation and contraction of the GDP. That year 1987, given the fall in international reserves and the closure of external financing, the Government evaluated the proposal to go to the IMF in search of financing, and in September the Zero Plan was presented, aimed at lifting price controls and restrictions on foreign trade. This plan did not have the expected result and it is in 1990 with the change of government that a structured program is applied to stabilize the economy.
Thus, in the mid-1990s, an oriented plan began to reduce hyperinflation and resume growth through structural reforms, supported by multilateral financing. The components of the stabilization program include the Fiscal Emergency Plan through which easy-to-collect taxes were established, such as the selective consumption tax, a temporary 10% tax on exports, a 1% tax on equity, and mainly, the price of gasoline was increased by thirty-four times, the central bank’s financing of the Government was prohibited from thirty days after granting it a loan to pay the public payroll, while the collection recovered. Tariff barriers were lowered and at the same time created a rule for increasing the prices of public services.
Regarding exchange, the discussion between a fixed or flexible exchange rate regimes favored a hybrid system, which started from the unification of the exchange rates from a 50% devaluation and the new level of the exchange rate. Instead, a target was set for the exchange rate that served as an anchor for the economy. Then, since September 1990, it was moved to an anchor based on a decreasing rate of the monetary base. The results were favorable with a sustained reduction in inflation to 6% in 1998, while the economy returned to growth.
As these experiences illustrate stopping hyperinflation is not only a difficult task but it is also an achievable task. There are some interesting differences across experiences that give a bit of margin for Venezuelan policymakers to choose alternative approaches. However, all economies that have been able to defeat it have done so by making major fiscal adjustments that eradicate the source of the unsustainable monetary expansions leading to hyperinflation. For hyperinflation to stop in Venezuela, the kind of policy changes requires will only be possible under a regime change. Any hope of achieving a credible stabilization plan requires new macroeconomic policies and support from international financial institutions that are not possible under the Maduro regime, whose only economic plan is the continued monetization of its fiscal deficits.
- Source: Permanent Commission of Finance and Economic Development of National Assembly of Venezuela, own calculations.
- Olivera, J. 1964. “On Structural Inflation and Latin America’s Structuralism.” Oxford Economic Papers. Tanzi, V. 1977. “Inflation, Lags, in Collection and the Real Value of Tax Revenue.” International Monetary Fund Staff Papers.
- Source: Central Bank of Venezuela, own calculations.
- See: Balance Preliminar de las Economías de América Latina y el Caribe 2020. https://www.cepal.org/es/publicaciones/46501-balance-preliminar-economias-america-latina-caribe-2020
- See: IMF World Economic Outlook, October 2020.
- See: https://www.bbc.com/mundo/noticias-america-latina-55202886
- See Reinhart, C., and M. A. Savastano. 2003. “The Realities of Modern Hyperinflation: Despite Falling Inflation Rates Worldwide, Hyperinflation Could Happen Again.” Finance & Development, International Monetary Fund, 20–23