The issue of Venezuelan inflation and hyperinflation is a common source of criticism for Modern Money Theory. Inflation, according to Keynesian economics, is defined as “a sustained rise in general prices over time (typically two quarters), which also corresponds to a loss in the domestic (internal) purchasing power of money.”
What is modern money theory?
Modern Money Theory (MMT) is a heterodox macroeconomic framework, according to which monetarily sovereign countries that conduct their transactions in fiat currency are not functionally constricted by revenues when it comes to government spending. Since the countries are monopoly issuers of the currency, they have the liberty to print as much currency as deemed necessary. This also implies that governments do not operate like a normal household or an enterprise in which revenue is required to be able to spend.
It helps to remember that MMT does recognize and acknowledge inflation and hyperinflation as dangerous consequences of printing currency and does not advocate nor support unlimited printing of currency. As a consequence, MMT advocates the implementation of a contractionary fiscal policy to destroy the excess money created in the market.
Inflation between the range of 2% to 5% is considered acceptable since it is the result of economic growth. Alternatively, the only times when high rates of inflation (even double digits) of inflation are not deemed harmful for the economy, is when the growth is higher than inflation. There are two reasons for inflation and hyperinflation.
Firstly, an increase in the money supply of a country is not backed by an increase in productivity or economic growth. Secondly, demand-pull inflation. A situation in which demand is higher than the supply of the product and that it drives prices up.
The case of Venezuela
Venezuela is a country on the northern coast of South America. With the largest oil reserves and the eighth-largest reserves of natural gas. The economy of Venezuela is primarily based on Petroleum and has been in a state of economic collapse since 2013, besides experiencing hyperinflation from 2015. Venezuelan is both a petrostate and rentier state. Total trade amounts to 48.1% of the country’s GDP. Exports accounted for 16.7% of GDP and petroleum products accounted for about 95% of those exports.
In the recent past, the Venezuelan economy has contracted by a total of 30%, with a fall in the production of oil. Agriculture, Industry and Services contribute 4.7%, 40.4%, and 54.9% respectively to GDP. According to official estimates, Venezuela has seen an increase in its inflation by 3332%
To understand the background, Venezuela is and has been in a state of continuous socioeconomic and political crisis. On 2nd June 2010, Hugo Chavez, the then president, declared an economic war. The crisis intensified in the Maduro government which spanned from 2013to 2018. Subsequently, his presidency was disputed with Juan Guaido in the year 2019 after premature and rigged elections. This crisis has affected the daily lives of every Venezuelan and has intensified the economic crisis. It has further reduced the confidence of various parties that could have contributed to the growth of the country and its economy.
Venezuela could easily have been the richest country in Latin America, but instead is in a state of catastrophe. The descent into an economic and political upheaval can be attributed to the following reasons: being a petrostate plagued with the Dutch disease, falling oil production, spiraling economy, soaring debt, hyperinflation, oil price shocks, political turmoil that made the country’s currency unstable, growing autocracy, social welfare programs, the printing of more money as a mechanism against the 2014 oil price shock and fall in demand for the Venezuelan currency.
Instead, mainstream economists believe that hyperinflation was a consequence of the government printing more currency to tackle the 2014 oil price shocks. Irrespective of popular economic belief, above mentioned reasons, have had a unique role in the making of and pushing inflation upward, transforming inflation into hyperinflation. The following reasons will further explain why printing currency was not the reason for inflation and hyperinflation.
First, MMT sheerly advocates the use of contractionary fiscal policy to negate the excess money in the market to avoid the eventuality of inflation and hyperinflation with increased access to money.
Second, the newly created money did not propel actual economic growth or increase the productivity of the already employed factors. This led to upward pressure on the prices. The reason behind the failure of creating actual economic growth or increasing productivity is the framework of the Venezuelan economy. It is heavily dependent on the oil sector and yet has failed to create an efficient and functioning system. The industry is rooted in corruption, red-tapism, etc. which only makes it less efficient and productive. The other sectors have been either ignored or not effectively made use of. This ensured that other sectors were either too nascent or lacked efficiency and productivity. The absence of directed investing of the newly created currency did not help the Venezuelan situation and made it worse.
Third, the Venezuelan economy was already in a foreign exchange crisis before they decided to print more currency. Having printed newer currency, they failed to adopt the appropriate fiscal policy. As a consequence, their currency got devalued.
Finally, when the Venezuelan government decided to print currency, the country had already constricted by more than 25%. It meant that there was more demand than the supply of products and services. Even if the case was otherwise, the affordability of the general public had drastically fallen due to inflation and widespread unemployment. As a result, driving the economy towards demand-pull inflation.
This points to the fact that the reason for inflation and then subsequently hyperinflation observed in Venezuela are: increased access to money, without actual increase in production; the inability of the government to pursue directed investing to propel economic growth and productivity; the absence of an appropriate fiscal policy.
Therefore, Venezuela cannot be quoted as an example of the failure of MMT. Though MMT advocates the printing of currency whenever deemed necessary, it is required to implement a contractionary fiscal policy. The latter part is significant since it will ensure the smooth functioning of an economy and guard it against a probable inflationary crisis. What happened in Venezuela was only half of what the theory suggests. The latter and the most important step was not executed. With the already existing predicament, the excess money contributed to the intensifying of the problems. What could have been a solution to the long-living crisis, became the inflexion point in Venezuela’s economic history.