CONTENT

1. Introduction……………………………………………………………….. 1
2. Theoretical Framework…………………………………………………… 3
3. Research and analysis…………………………………………….……….. 4
4. Recommendation and Action Plan……………………………….……….. 8
5. Bibliography………………………………………………………………. 9

LIST OF TABLES
1. Table 1……………………………………………………………………… 5

LIST OF FIGURES

1. Fig 1: IS-LM Curve of Venezuela in Hyperinflation………………………. 4

2. Fig 2: Phillips Curve - Venezuela (2014-19) ………………………………. 5
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EXECUTIVE SUMMARY

Hyperinflation is a situation that occurs in countries when the inflation rates are very high.
This condition may occur due to certain political situations, natural calamities, faulty fiscal and
monetary policies, trade policies, or accumulation of debts. In Venezuela the economy is very
much dependent on oil market. The government took a lot of loans from foreign markets,
especially from Russia and China and used this money to provide subsidies to the citizens.
Their dependence on these subsidies was too high. But when there were turbulences in the oil
market the government was not able to carry on these subsidies and the currency rate declined.
We have studied this situation in detail and understood the role of various stakeholders that
were involved in the formation of such a situation. We linked their current situation with the
concepts of Quantity theory of money, Demand pull inflation, Cost push theory, IS-LM curve
and Philips curve and applied them to do a detailed analysis. We also did a detailed study of
the various causes that has worsened the situation over the years. Based on our findings and
our secondary research we were able to suggest the alternatives available. Towards the end of
our report, we have a plan of action that should be adopted by the country to improve their
current economic and humanitarian conditions.
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INTRODUCTION

A. What is Hyperinflation?
Hyperinflation starts when a country's government begins printing money to pay for its
spending. There is excessive and out of control hike in the prices in an economy. While
Inflation refers to the rate of rise in the general price level of an economy, Hyperinflation is
a very high Inflation. It occurs when the prices of commodities increase by over 50% per
month for a period of time. Hyperinflation requires customers and businesses to shell out
more money to buy the same basket of goods. While normal Inflation is generally measured
on a monthly or even annual basis, Hyperinflation is measured as daily exponential increases
in prices.

This occurs when the customers have more money to spend with them thus increasing their
demand. On the contrary, the supply for goods and services does not increase in proportion
to increase in demand. Due to this mismatch, people are willing to pay higher prices for the
same commodity as they have more currency at their disposal. As a result of this, the overall
value of the currency drops. When this rise in prices occurs on a daily basis, exponentially,
it is called Hyperinflation.

B. What happened in Venezuela?

It is a country in South America, which is heavily dependent on oil exports. Under its former
President, Hugo Chavez’s reign the country was a socialist and spent lavishly on the public
with almost 50% of its GDP coming from public spending. Even though this was good for
the people it did not do good to the economy. As by pumping money, he increased the money
supply without a corresponding increase in the supply. High dependence on oil made and a
sudden drop in the global oil prices aggravated the situation further. Also, the poor economic
mismanagement of paying the country’s debts by reckless printing of currency worsened the
situation. As a result of many other causes bundled up, Venezuela is currently facing
Hyperinflation.

Hyperinflation in Venezuela began in November 2016 during the country’s socioeconomic

and political crisis. From 2006 to 2012 the inflation rate was declining during the entire
period. The inflation rate suddenly started increasing in 2013 and continued to increase in the
following years with inflation exceeding 10,00,000% in 2018.
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In 2014 it reached 69%, the highest in the world. In 2015, it was 181% again the highest in
the world. It reached 800% in 2016, over 4000% in 2017 and 1,698,488% in 2018 with
Venezuela spiralling into hyperinflation. In April 2019, The International Monetary Fund
estimated that inflation would reach 10,000,000% by the end of 2019.

For example: At a monthly inflation rate of 50%, an item that costs $1 on January, 2018
would cost $130 on January 1, 2019. According to an August 2018 BBC article, prices of
goods have been doubling every 26 days on average, and the annual inflation rate reached
83,000% in July, 2018. It was also found that one cup of coffee cost 450 Bolivars in
Venezuela less than two years ago. Earlier in 2018, it costed a shocking 2.5 million Bolivars.
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THEORETICAL FRAMEWORK

Quantity Theory of Money

This theory basically stresses that a change in the general price level of an economy, are
caused due to changes in the money supply in circulation within the country.

Demand Pull Inflation

When the value of aggregate demand exceeds that of aggregate supply, an inflationary gap
arises given that the economy is at full employment. Aggregate demand comprises of
consumption, investment and government expenditure.

Cost Push Theory

Cost-Push Inflation is caused due to increase in prices of inputs like labour, raw material, etc.
An increase in the price of factors of production will lead to a decrease in the supply of these
goods.

IS-LM Curve
The IS-LM Curve Model shows the interaction between the Goods and Money market. The
IS-LM Curve interacts to show a short-run equilibrium between interest rates and output.

Phillips Curve
It states that the change in unemployment in an economy has a predictable effect on price
inflation. The theory claims that with economic growth comes inflation which in turn leads
to more jobs and less unemployment.
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RESEARCH AND ANALYSIS

A. Application of Theoretical Concepts:

Quantity Theory of Money: Because of the reckless printing of notes by the government to
repay their debts, government spending was 50% of the GDP. Thus, currency in circulation
increased which caused the hyperinflation.
Demand Pull Inflation: Due to an increase in the currency with the public, the demand for
goods and services increased. But the same was not the case in the supply side, as the only
industry which flourished in Venezuela was the Oil Industry.
Cost Push Inflation: To reduce unemployment, Chavez’s government employed most of the
unemployed in the National Oil Company of Venezuela, PDVSA, even though they did not
contribute to the productivity of the organisation. This resulted in higher and unjustified
costs of production. While, global oil prices fell due to the OPEC countries, cost of
Venezuelan oil rose. This led to a major loss in revenue to the government which lead to
mass layoffs in the coming years.

IS-LM Curve Analysis:

Source: flypapereffect.wordpress.com

Fig 1: IS-LM Curve of Venezuela in Hyperinflation

Note: Due to unavailability of data, we have used various parameters to assume the
movement of the IS and LM Curves.

Reason for Rightward movement of the IS Curve: Devaluation of Currency/ Fall in the Real
Exchange Rate of the country/ Exogenous Increase in consumption leads to an increase in
income at each level of interest rate.
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Reason for Leftward movement of the LM Curve: An increase in money supply leading to
reduction in the demand for money shifts LM curve to the right.
Phillips Curve:

Source: Table 1

Fig 2: Phillips Curve - Venezuela (2014-19)

YEAR UEMPLOYMENT RATE INFLATION RATE
2014 6.7 69
2015 4.4 181
2016 20.86 800
2017 27.886 4000
2018 35.027 1698488
2019 40 10000000
Source: Data from IMF
Table 1: Unemployment and Inflation Rate of Venezuela (2014-19)

B. CAUSES

The following can be summed up as the causes for the Hyperinflation that Venezuela is
currently facing:
1. Increased Government Spending
2. Decline in oil prices
3. Improper economic management
During the presidency of Hugo Chavez since 1999 to 2013, several social welfare programs
“Bolivarian Missions” were established to improve the living conditions for the poor by
redistributing wealth and reforming land laws. There were attempts to promote economic
democratization with the establishment of worker-owner cooperation. According to the
Centre for Economic and Policy Research, these policies, they reduced unemployment rate
from 14.5% in 1999 to 7.89% in 2011. Extreme poverty declined to 8.6% in 2011 from 19.9
% in 1999. According to CNBC, the Government spending was higher than 50% of GDP in
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2012. At the same time, to keep the programs consistent the Government borrowed from
other countries and central bank. By 2012, Venezuela had a debt over $106 billion. Chavez
and his administration also failed to save money for future crisis.
Venezuela has the largest oil reserves in the World with 50 % of its GDP derived from
exporting petroleum exports which accounts for 95% of total exports. According to
American Institute of Economic Research In 2014, prices of oil dropped sharply from $100
to $70 a barrel and then to $33 a barrel in early 2016. Lower oil price along with widening
fiscal deficit led further financing from the central bank. Sharp money supply growth led to
high and swelling inflation in 2017, ultimately leading into hyperinflation. Venezuela had
debt of 500% of current account, which was the highest in the World.
The incumbent President Nicolas Maduro, in order to bridge the existing budget gap
has initiated policies to print more money to pay the debts. Budget shortfall was resolved
but hyperinflation aggravated destroying private investment. Maduro was following
disastrous economic policies and refused to address the matter diligently.

C. ALTERNATIVES

1. Dollarization
 Extensive use of U.S. dollar alongside/instead of the domestic currency leads to
Dollarization
 This usually occurs when a country's own currency loses its usefulness as a medium
of exchange, due to hyperinflation or instability
 Dollarization can occur unofficially without formal legal approval or officially,
when a country ceases to issue a domestic currency and uses only U. S. dollar
 Official dollarization has gained prominence since past few years.
 Basic features of dollarization: varieties it takes, where it exists, its working, costs
and benefits of official dollarization and issues that arise while implementing official
dollarization

2. Focus on Oil
 If the production level of the oils can be restored to that of 2013, assuming the price
to be $50 per barrel, $80 billion can be restored in two years
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 New laws can be formed for foreign and private companies so that they can invest
capital in energy resources and there can be healthy competition in the market with
good tax rates to ensure unfair administration
 The skilled labour force should be restored

Disadvantage-
 Venezuela has been vulnerable to boom and bust commodity cycles because of its
major dependency on oil prices and markets.
 In such a situation when the oil market is doing well the country took advantage
of the situation but even a slight fluctuation in the market results in a dip in the
economy, and when again the market performs well the economy is restored. This
has not been a helpful situation for the country

3. Cryptocurrency
The government is already using a “Petro”, that is backed by oil and mineral’s
prices. But keeping in mind the current scenario other cryptocurrencies should be
introduced.
Since the blockchain is decentralized, distributed and distributed ledger,
transactions will be transparent and reduce the intervention of the government and
will give more power to the private companies.

4. Special Economic Zone

 To encourage investments, setting up of special economic zones is recommended
wherein the trade laws of the SEZ will be different from the rest of the country
 This has been well executed in case of freeports at Malta
 These SEZ can be accessible for FDIs as well to boost the economy

5. Monetary help from IMF and other nations

 An estimated loan of $60-$80 billion will be needed to be given to the government
spread in course of 3-5 years
 This loan can be borrowed from IMF or other nations who are willing to help
 This will boost the economy and help the government get rid of the massive debt
 Russia and China are the major creditors with their own accounts of billions of
dollars to settle
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RECOMMENDATION AND ACTION PLAN

1. The government should stop printing of more currency as it is increasing inflation by

devaluing it by 95%
2. Establish an independent and sovereign authority to regulate and formulate fiscal and
monetary policies
3. Create Special Economic Zones wherein different trade policies will be implemented
and would involve more numbers of private investment
4. The current currency should be disregarded and dependence on “Petro” should be
minimized
5. Use of dollar should be encouraged in special economic zones and with time new
cryptocurrencies should be used in the market
6. The government should build the confidence of its citizens and work on restoring the
skilled labour force so that the oil market can be slowly restored
7. With the help of international agencies an unbiased election should be conducted so that
people can form their own government
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BIBLIOGRAPHY

1. https://medium.com/hackernoon/a-part-solution-to-the-venezuelan-crisis-
cf3e33858e89

2. https://www.reuters.com/article/us-venezuela-politics-breakingviews/breakingviews-
breakdown-how-to-fix-venezuela-idUSKCN1PT1Q0

3. https://knowledge.wharton.upenn.edu/article/venezuela-extricate-crisis-recover/

4. https://cedice.org.ve/the-only-solution-for-the-economy-of-venezuela-is-dollarization/

5. http://www.ipedr.com/vol4/91-F10116.pdf

6. https://latinamericanpost.com/28269-venezuela-how-have-other-countries-solved-
their-inflation-crises
7. Morris A. Davis, Macroeconomics for MBAs and Masters of Finance, 1st edition
8. Rudiger-Stanley-Richard, Macroeconomics, 12th edition