For the past five decades, Venezuela has enjoyed a stable and rising economy. The country was one of the founding members of the Organization of Petroleum Exporting Countries. The citizens of Venezuela have over the years continued to enjoy the revenues generated from exporting petroleum product. The government has provided well-equipped hospital facilities, subsidized food products and provided free gasoline to its citizens (Globe mail 2015). However, Venezuela is not reading from the same script it read twenty years ago. The country is plunged into an economic and political crisis. Oil prices have dropped by more than fifty percent and the prices of essential commodities such as food has increased significantly. With the help of the IS-LM model, this essay sets out to examine the inflation crisis in Venezuela and offer remedies to the situation.
As the country is amidst peace talks after a political crisis, the manufacturing and production industries of the country have been severely affected. The country depends heavily on imports it cannot afford. The falling of oil prices in the international market has been a big blow to Venezuelan foreign trade. Venezuela is selling one barrel of oil at $45.21 this year (2015) compared with $88.42 in 2014. In a move to correct the deficit balance of trade, the Venezuelan government has reduced imports by 18 %. This move has in turn created widespread shortages of medical and food supplies and other staples. Violence and other criminal activities have also been on the rise as people look for alternatives to provide for themselves necessities.
Since oil exportation accounts for over 95% of Venezuelan foreign currency earnings, the foreign reserves of the country have fallen by 15% from $24.2 billion to $20.6 billion in a short period of six weeks. The country is in hyperinflation with economics specialists predicting it to go over 150% in 2015 and over 250% if the government includes other data that are omitted in calculating the inflation rate.
The inflation levels of Venezuela can be analyzed with the IS-LM model. The model scrutinizes the money markets (LM curve) and the goods markets (IS curve), then bring the two to a point of equilibrium. At this point of equilibrium, the inflation levels are at a minimum since there cannot be zero levels of inflation.
The IS-LM model assumes Venezuela is a medium open economy. The government should devalue the currency of Venezuela. With a devalued currency, oil and other exports from Venezuela will be relatively cheaper in the foreign market thus attracting buyers. This will in turn increase the revenues of the country, and the deficit balance of trade will be corrected to a normal or even a surplus. With a normal or surplus balance of trade, the government can lift the bans on importation so as to provide its citizens with commodities, as it awaits the country’s manufacturing and producing industry to pick up. Since there is a deficit of funds that are circulating in the economy of Venezuela as a result of decreased exportation of oil and decreased government expenditure on infrastructure and social services provisions, the government can employ monetary policies such as reducing the interest rates. With a reduced interest rate, the public will be motivated to borrow loans from commercial banks to purchase commodities. The diagram below explains how the money markets will be affected by the lowering of interest rates. Notice how the LM curve (money markets) shifts.
Bibliography
The Globe and Mail,. 'How Powerhouse Venezuela Has Turned Into A Pauper'. Last modified 2015. Accessed June 21, 2015.
http://www.theglobeandmail.com/news/world/how-powerhouse-venezuela-has-turned-into-a-pauper/article23666497/.
Rosati, Andrew. 'Venezuela Inflation Seen Pushing 200% As Rationing Deepens'. Bloomberg.Com. Last modified 2015. Accessed June 21, 2015. http://www.bloomberg.com/news/articles/2015-04-10/bofa-sees-venezuelan-inflation-spiraling-to-as-much-as-200-.
