In search of stabilization and recovery: macro policy and reforms in Venezuela

ABSTRACT

Venezuela is currently immersed in a severe economic crisis as a result of years of domestic mismanagement and the recent reversal in oil prices. This article attempts to formulate a proposal for stabilization and recovery that includes upfront key policy actions to deal with the drastic foreign exchange constraint. We consider the recovery of foreign currency liquidity to be of paramount importance. This will allow not only the lifting of exchange control and the implementation of a stable and competitive real exchange rate, but also the removal of shortages across the board and output recovery. The recovery of domestic activity will also require supply-side relief in the form of broad deregulation, institutional changes, and a sensible policy to lift price controls. To maintain a stable and competitive exchange rate, we propose a whole set of policy measures for rapid suppression of inflation and the causal mechanisms that have formed over the years. A monetary reform and the support of monetary and fiscal policy for successful stabilization and recovery efforts are also discussed.

KEYWORDS:

• Foreign exchange constraint
• inflation
• reforms
• stabilization
• Venezuela

JEL CLASSIFICATIONS:

• E60
• H12
• O54

Notes

¹Elsewhere (Vera, 2015), we have presented an analysis and description of the recent evolution of the Venezuelan economy.

²In the case of PetroCaribe, the major energy program in the region, a group of countries from Central America and the Caribbean purchase oil and oil products from Venezuela and the differential between the market price and a referential discounted price is turned into a 25 year loan at concessional terms.

³Though this arrangement will imply the existence of parallel exchange rate market, its behavior will depend on a number of factors, in particular the behavior of expectations regarding the credibility and sustainability of the stable and competitive real exchange rate (SCRER) system.

⁴All these authors understand a “competitive” real exchange rate as one that is above its equilibrium level.

⁵Here it is critical to know or have an idea of the elasticity of the demand for reserves with respect to an increase in exchange rate system flexibility.

⁶If the exchange rate changes rapidly, up or down, traders and investors will become more uncertain about the profitability of trades and investments and will likely reduce their international activities. As a consequence, international traders and investors tend to prefer more stable exchange rates and will often pressure governments and central banks to intervene in the foreign exchange (forex) market whenever the exchange rate changes too rapidly.

⁷With no updated official figures of Venezuela’s oil deliveries to China, it is difficult to confirm these speculations.

⁸Contreras and Guarata (2013) confirm this causality from relative price variability to inflation in Venezuela using monthly data for the period 2000:1–2011:10.

⁹As the new “supply-side” theory of inflation contends, when the distribution of price changes is positively skewed and downward price inflexibility prevails, large or even small increases in the prices of few goods may be associated with an increase in average inflation. The theoretical proof belongs to the work of Olivera (1960, 1964), although Ball and Mankiw (1995) later provided an explanation in a statistical sense.

¹⁰We should not underestimate, however, the positive welfare effects that radical elimination of shortages and queues and a broader variety of goods and services may have on the general public.

¹¹The Real Plan was in essence a three-pillar, three-stage stabilization program with a budget-balancing mechanism, the introduction of a stable unit of account to align the most important relative prices in the economy, and the conversion of this account unit into a new currency at a fixed par rate with the U.S. dollar.

¹²Venezuela is ranked 186th out of 189 economies in Doing Business 2015.

¹³In Vera (2015) we show that this accumulated stock of liquid resources (whose counterpart comes as short-term debt instruments) is highly correlated with the ratio of M2 to international reserves. Hence, more liquidity chasing the same restricted volume of output, and chasing the same amount of dollars, has a potential impact on both inflation and exchange rate depreciation dynamics.

¹⁴Definition of the consolidated public sector covers only the central government and the state-owned oil monopoly PDVSA. No data are available on the social security system, or other state-owned enterprises. None of the series includes off-budget funds such as Fonden or the Chinese Funds.

¹⁵Manzano and Scrofina (2011) argue that these vehicles have been used to bypass the formal budget and have provided the government discretion and flexibility because they are not bound to the same legal entitlements and earmarks as the formal budget.

¹⁶Both households and firms will continue not only to hold domestic currency but also to hold it in growing amounts because they will feel that through full indexation they are protected against inflation.

Additional information

Notes on contributors

Leonardo Vera

Leonardo Vera is a full professor at Universidad Central De Venezuela, Faces, Escuela de Economía, Ciudad Universitaria, Caracas.