Hyperinflation or just high inflation?

Our BCV President Merentes

Is Venezuela headed towards hyperinflation?

A few days ago, Quico dismissed allegations of runaway hyperinflation in the country. He used a report put out by Francisco Rodriguez and his team at BofA using over five thousand regressions to estimate the annualised inflation rate of Venezuela based on the few economic indicators we have. His conclusion was that we’re not yet into the abyss. Rodriguez estimates that the inflation rate in Venezuela may be hovering around 100%, which is probably true, shocking, but yet in the realm of hyper-inflation.

Is that where we’re headed?

It’s difficult to overstate the trauma that hyperinflation represents. About 7 years ago I had the opportunity to attend a Summer School Program at the London School of Economics. As the world was about to fall apart into the greatest economic crisis since the Great Depression, I befriended a Zimbabwean lad who gave me a 5 billion Zimbabwean dollar bill as a gift. By that time, Zimbabwe’s currency was worthless, and the economy operated mainly on bartering. This was an economy with high chronic inflation, which led to the first case of hyperinflation in the XXI century: in July 2008 the inflation rate reached over 230 million %! Pretty soon, the currency collapsed altogether and the US dollar was introduced as legal currency.

Some of you think we are already in Zimbabwe territory. Truth is, we’re not yet. Will Venezuela ever enter an hyperinflationary economy?

The answer may lie in a report made by the IMF a decade ago. In it, economists Carmen Reinhart and Miguel Savastano studied the hyperinflationary crisis-and-stabilization episodes to yield some insightful conclusions. This report claims that hyperinflations have certain common features.

Modern hyperinflations take place in countries with a history of high chronic inflation, although high chronic inflation episodes don’t necessarily lead to hyperinflation. Also, hyperinflation is fueled by an uncontrolled monetary expansion which is usually prompted by fiscal imbalances and severe economic distortions ranging from financial repression to capital controls. Sound familiar?

The worst part of it all is that hyperinflations, contrary to the conventional wisdom, may last longer than previously thought, given that economic output does not jumpstart quickly enough due to an array of issues. Whether we like it or not, dollarization appears to be a lasting legacy in each case of hyperinflation.

So you see here folks that the regime is on sound footing towards the abyss. If the heads of the BCV, Maduro’s economic policy team, or someone (including the opposition) wishes to pay attention to our macrodisasters, please bear in mind these 7 lessons to learn from this report:

1. Hyperinflations seldom materialize overnight and are usually preceded by a protracted period of high and variable inflation (check).

2. Stabilization may take years if fiscal policies are not adjusted appropriately. Even when fiscal adjustment is implemented, it takes time to achieve low inflation, especially when money is used as the nominal anchor.

3. Sharp reductions in fiscal deficits are always a critical element of a stabilization program, regardless of the choice of monetary anchor.

4. Unifying exchange markets and establishing currency convertibility are often essential ingredients of stabilization, irrespective of the choice of main nominal anchor (Simadi, SICAD, anyone?).

5. Output collapses during, and sometimes in the run-up to, hyperinflation. Although stabilization measures cap the implosion in economic activity, there is little evidence to suggest that they kindle a robust rebound in economic activity.

6. Hyperinflations are accompanied by an abrupt reduction in financial intermediation.

7. Stopping a hyperinflation does not restore demand for domestic money and domestic currency assets to the levels that prevailed before the hyperinflation began.

We may not be in a hyper-inflation just yet, but can anyone doubt where we’re headed?