“Inflation is always and everywhere a monetary phenomenon,” is a statement by the American economist Milton Friedman (Nobel laureate in 1973) that continues to resonate in classrooms and explanations of price increases. However, in Venezuela, it is an argument that is “destined to be, at least, incomplete,” according to economists Luis Zambrano Sequín, Santiago Sosa, and María Antonia Moreno from the Institute of Economic and Social Research at the Universidad Católica Andrés Bello (Ucab).
In a document titled “What Factors are Explaining Inflation in Venezuela?” published this month, the experts point out that the country “is a very illustrative example that inflation, especially when it is a prolonged phenomenon, is the result of multiple factors.”
Sequín, Sosa, and Moreno indicate that the results of their study “account for the complexity of the Venezuelan inflationary process and its multicausal nature,” pointing to various factors “that can be as or more important than the behavior of monetary aggregates.”
The paper is a technical document in which an “estimation of a restricted Vector Autoregression Model (VEC)” is performed. However, apart from econometric details, their conclusions can be summarized in seven factors that explain why inflation in Venezuela is so high:
Inflationary Financing: Monetary financing of the fiscal deficit is one of the main drivers of monetary expansion and, consequently, inflation. While it has reduced compared to past hyperinflation, it remains relevant. They detail that “the high government dependence” on inflationary taxation intensified from 2015, and now “the contraction of economic activity, increasing informality, the cessation of international financing (due to default), and more recently, international sanctions imposed on the government have made inflationary taxation the main form of government financing.”
Inflation Inertia and Expectations: Indexation mechanisms, where prices and wages adjust automatically based on past inflation, contribute to maintaining the inflationary spiral and hinder its reduction. The way economic agents perceive and anticipate future inflation affects their behavior and pricing and wage decisions, perpetuating high inflation.
They point out that “the recurrence of high inflation, sooner or later, induces the development of various price indexation mechanisms based on the most recent inflation history, through which different economic agents try to protect their income.”
“Reducing the inertial nature of inflation, which is essential in our case, requires desindexation instruments for prices and wages, which implies not only income policy measures but also coordination between entrepreneurs, wage earners, and the government. Unfortunately, the high degree of informality in the economy and the weakness of the institutional framework hinder progress in this matter,” they indicate.
Exchange Rate Policy and Dollarization: The management of the exchange rate policy and the degree of dollarization in the economy can have significant impacts on Venezuelan inflation. They state that “there is ample evidence that in countries with a high degree of dollarization, the speed at which exchange rate adjustments and inflation are transmitted accelerates.”
“The progress in the dollarization of the economy weakens, until it cancels out, the capacity of monetary and exchange rate policies as stabilizing instruments. The situation becomes even more critical with the lack of access to international financing and the irreversible shrinking of the domestic financial system,” they note.
Government Intervention: Government intervention in price and production cost setting, as well as income policy implementation, is also another inflationary factor.
Political and Institutional Instability: Political and institutional restrictions in Venezuela hinder the implementation of effective policies to combat inflation. They affirm that currently, “there is a long way to go in meeting the minimum political and institutional conditions necessary for a successful anti-inflationary policy.”
Inappropriate Exchange Rate Policy: The current policy of mini-devaluations of the exchange rate may fuel the inertial nature of inflation and may not be consistent with a long-term anti-inflationary strategy.
External Price Pressure: Negative effects from international events, such as the pandemic, the Russian invasion of Ukraine, or geopolitical changes, have exerted pressure on inflation in Venezuela. They explain that “from mid-2020, inflation in prices in external markets, as well as the depreciation of currencies in several countries of origin of our imports, varied at relatively high rates, in line with the acceleration of inflation rates worldwide.”