2
$\begingroup$

I am struggling to understand why governments, when faced with hyperinflation, often let it drag out for years rather than bite the bullet and replace the currency. Given that by that point the domestic currency financial sector is non-existent, that there are significant costs associated with hyperinflations, and that it is usually too difficult to stop once it has begun, it isn’t obvious to me why a government chooses to allow the situation to persist rather than introducing a new currency and commit to fixing the underlying disequilibria driving the inflation in the first place i.e. achieve a balanced budget. Are the governments in places such as Venezuela incompetent or is there something I am missing? Thank you in advance!

$\endgroup$

2 Answers 2

5
$\begingroup$
  1. Introducing new currency won't help if the underlaying problems are not addressed.

In fact as reported by AlJazeera:

Venezuela introduces new currency, drops six zeros

So they are already introducing new currency, but this won't really stop inflation unless the underlaying issues are addressed.

Introducing new currency just 'resets' the number of zeros on the banknotes, I know of no economic theory pertaining to inflation that would suggest that alone could solve inflation. If it would be that easy no country would ever experience hyperinflation.

  1. Asking why the government just doesn't fix all the disequilibria, bad policies and balance the budget, is equivalent of asking, why just Israelites and Palestinians cannot sit down and partition Judea in some fair way?

Short answer is that things are simply more nuanced.

For example, when it comes to balancing the budget there are many stakeholders that Venezuelan government has to consider. If they cut military budget, the regime could loose support of the military. If they cut pensions then that will anger masses etc. etc.

This is not necessarily about being incompetent. Even though I don't think most politicians are very competent even poor countries can easily afford to hire ivy-league economists. However, in democracy one cannot just start 'fixing things' without making sure that majority of people are on board with any changes. Even if nobody likes hyperinflation there are still people who befit from policies that are leading up to it. For some people keeping some policies that reward them large rents might be enough to compensate for living with hyperinflation.

You can have look at various models presented in Public Choice III by Mueller in part III which show that even fully rational people might favour various policies that are ruinous for country because of prisoner dilemma styles-problems, rent seeking etc.

Even if you consider Venezuela at this point to be a dictatorship, which is probably fair assessment, the same problems remain (see Mueller ibid ch 18). In fact in a Dictatorship these problems could be even more severe. According to Mueller pp 416:

we see that citizens will experience differential gains and loses from governmental policies under a dictatorship as in a democracy. Rent seeking will take place and different groups will compete for these rents. To achieve his goals, the dictator must determine who his true supporters and enemies are, whom to reward, and whom to punish ... In a democracy this information is readily available. Interest groups offer visible support for a party in the form of votes and campaign contributions, and a politician can fairly easily determine which groups are most loyal to him - which groups deserve rewards. But in a dictatorship support for the government is much more passive. It takes the form of not actively opposing the government, not sabotaging its policies and starting a revolution to overthrow it, and so forth. All groups have an incentive to fain support for the dictatorship even if they are actively working to undermine it. The dictator faces the daunting task of determining which groups truly support him which are merely pretending to do so, and which are actively but secretly plotting his overthrow.

... To build support for his regime the dictator needs a way of credibly signaling to those whose loyalty he seeks to win that he will not subsequently turn upon them. Those seeking rents and other rewards from the dictator need a way of signaling their willingness to trade their loyalty for rents. Most generally, the dictator needs criteria who should be rewarded and who not, and who should be the target of repression. Here ideology can play a useful role. ... Ihe ideology of the regime identifies the likely winners and losers from governmental policy, and commits the dictator to some degree not to employ repression against members of the state religion. The existence of state religion helps to make the dictators promises credible. Other criteria for differentiating among the citizenry have been by economic interest (Communism) and ethnic group (Fascism Apartheid, Nationalism).

So for example, it can be fully rational for dictator to commit to lets say to communist ideology (e.g. Kim Jong-un) even if the dictator knows that its not sane economic policy (I somehow doubt Kim Jong-un is devout communist or that he actually thinks absence of private property, private enterprise or free trade benefits his country etc). Similarly Venezuelan leadership can simply use support for policies of its 'socialismo del siglo XXI', regardless whether those policies are economically sound or not.

Creating bad policies in not irrational per se.

This beings said, it is also possible that irrationality plays some role (see Mueller ibid ch 28), but its simply not just given. Even if irrationality is present it would be in some form of behavioral deviations from purely rational behavior not complete incompetence. Surviving as a dictator takes some level of cunning.

$\endgroup$
4
$\begingroup$

Venezuela changed its currency 4 times since 2008. VEB, VES, VEF plus another denomination with a change in iso code mentioned in the other answer.

Changing a currency changes nothing. Changing behaviour would.

However, if your child didn't behave for years, you don't trust your loved one just because it put on a fresh pair of pants. Same for countries.

What would change the situation pretty radically is a currency board because that puts a fairly definitiv end to the printing press. However, there are a few issues on its own:

  • You give up monetary policy for good because you need to follow the policies of a foreign central bank.
  • Inflation expectations don't disappear over night. Usually, stable exchange rates but higher inflation compared to (usually) the USD, results in loss of competitiveness to name just two.

I recommend for example Krugman's book "Return of Depression Economics" for a brilliant non technical explanation of (currency) crises.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.