Felix E. Alvarez P.
This is the english version of the post titled La Demencia de una Política Monetaria.
Monetary policy can be defined as the set of actions taken by Central Banks in order to influence monetary variables and pursue objectives such as price stability and economic growth. Monetary policy manages the quantity of money in an economy, influences interest rates, the money market, the exchange rate and the financial conditions of the system. In terms of its scope, Friedman (1968) says that monetary policy must do the following things: to prevent money from generating distortions in the system, to give predictability to economic agents about policy objectives, and to be a force that acts countercyclically, counteracting shocks that threaten the stability of the economy.
The implementation of this policy is carried out by Central Banks, entities that manage the quantity of money in an economy, the centralization of foreign reserves, the issuance of legal tender of a country, among other functions. An independent central bank makes adjustments to its policy based on the prevailing conditions in the economy and is a key piece for the stabilization of the system. In this way, central banks have adequate leeway to apply stabilization policies when required, without implying that they fall into time inconsistency, undermining their reputation as to their policy objectives (Montiel, 2011).
None of the above exists in Venezuela because there is no independent Central Bank. What we have today is one completely submissive to the will of the Executive Power and limited to things such as continuously incurring in financing the fiscal deficit and not publishing data. Hence, for example, the decision of the National Assembly with Deputy José Guerra, President of the Committee on Finance and Economic Development, to start publishing his own estimates of inflation and other macro variables is so positive. The reasons that generate the economic crisis that Venezuela lives today are domestic, specifically the populist economic policy of a model that uses money printing to finance deficit policies regardless of the costs associated with it. It is a government that persists in the idea of imposing a retrograde and unviable economic model.
Nowadays the monetary authority violates the Constitution of the Republic in different articles where the functions of the BCV are exposed. For example, having a three-digit inflation and the highest in the world, violates Article 318 which clearly states that the Central Bank aims to “la estabilidad de precios y preservar el valor interno y externo de la unidad monetaria” [maintain price stability and preserve the internal and external value of the monetary unit]. Another serious misconduct of the Magna Carta is the non-compliance of article 320 where it is said specifically that:
This is how over the last 12 years, a series of changes in monetary legislation have taken place with the purpose of giving continuity to the populist economic policy, whose internal dynamics is in itself unsustainable. These reforms stem from some kind of legal modification that changes the way in which the government can continue to finance its growing fiscal spending. It is like looking for alternatives to finance because it is not enough with what you have, due to mismanagement. The outcome of this is the progressive loss of the bolivar's value, where the Central Bank is increasingly dependent on the political decisions of the Government and more inclined towards an inflationary monetary policy, without any concern for price stability as an objective.
Basically the monetary reforms have had as objective: 1) to enable other sources of fiscal financing in bolivars, 2) to increase the power of the Executive over the monetary authority and 3) accounting relaxations. The beginning of the inflationary spiral that we have today can be identified in the reform of the Central Bank Act of 2005 that creates the FONDEN, whose financing implies both double monetization and the estimate of “el nivel adecuado de las reservas internacionales de la República” [the adequate level of the international reserves of the Republic]. The latter constitutes a discretionary use by the Central Government of resources in foreign currency that would otherwise be part of the country's international reserves, and whose methodology has never been explained, less applied, as various economists have pointed out. Among others, the reformed article 113 of the law legalizes, in short, the origin of the current inflationary crisis of the country.
It also specifies the first transfer that the Central Bank should make to FONDEN of $6B. Until last year the BCV has transferred to the fund more than $50B. PDVSA has also transferred resources to FONDEN, thanks to another infamous legislation lacking economic rationality and that of course contributed in generating the unleashed fiscal and monetary dynamics that we live today.
Four years later, the model based on double monetization and taking of international reserves to finance the treasury showed signs of exhaustion given its lack of wisdom, despite the fact that in 2008 we had soaring oil prices (in June 2008 the average Venezuelan basket arrived at 129.54 $/b). This motivated the government to make another modification to the monetary legislation, whose purpose was similar to that of the previous reform: to open another space for monetary financing of fiscal policy. So that at the end of 2009 another BCV reform is promulgated, where the printing of money to finance the treasury is allowed. The modified and fateful numeral 6 of article 48 of the law:
And with this begins the growth of inorganic money aimed at government companies. As of 2011, the BCV's financing to PDVSA grew at an average annual rate of 202%, pouring to the money flow the huge amount of Bs.5,6T (up 496% from December 2015) to the end of 2016. Each one of them, inflationary bolivars. Omar Zambrano said at the end of 2013:
The reform of 2014 brings with it among other things, the relaxation of the concept of international reserves with the amendment of article 127, and the limitation of the sale of PDVSA's foreign currency to the Central Bank with the reform of article 125, which seeks to have a greater discretion in the use of the flow of resources in foreign currency that the nation receives via oil activity. Another reform that subjugates more the BCV to the Executive Power.
Finally, in 2015 the reform of the BCV Act goes even further in the control over the monetary authority and the lack of transparency. This reform includes among others: a) the appointment of the President and the entire BCV board by the President of the Republic without having to go through the National Assembly, b) the prohibition of publication of data ordered by the Executive, when these "representen una amenaza a la Seguridad Nacional y a la estabilidad económica de la Nación" [pose a threat to the National Security and to the economic stability of the Nation], and c) to grant credits to the Government when there are threats qualified as such by the President of the Republic. In relation to the latter, numeral 2 of article 37 contains the pernicious modification:
In conclusion, if one wishes to explain the monetary policy of chavismo in recent years, reforms to the BCV Act have been fundamental, since they have generated the conditions that put Venezuela at the gates of a hyperinflationary process and that without a doubt have contributed to the current unprecedented crisis of the national economy. In relations to this, Friedman warned of the dangerous effects of negligent monetary policy on the real sector of the economy (1968, p.12).
References
Nowadays the monetary authority violates the Constitution of the Republic in different articles where the functions of the BCV are exposed. For example, having a three-digit inflation and the highest in the world, violates Article 318 which clearly states that the Central Bank aims to “la estabilidad de precios y preservar el valor interno y externo de la unidad monetaria” [maintain price stability and preserve the internal and external value of the monetary unit]. Another serious misconduct of the Magna Carta is the non-compliance of article 320 where it is said specifically that:
“… el Banco Central de Venezuela no estará subordinado a directivas del Poder Ejecutivo y no podrá convalidar o financiar políticas fiscales deficitarias.” [the Central Bank of Venezuela will not be subordinated to directives of the Executive Power and will not be able to validate or finance deficit fiscal policies.]
This is how over the last 12 years, a series of changes in monetary legislation have taken place with the purpose of giving continuity to the populist economic policy, whose internal dynamics is in itself unsustainable. These reforms stem from some kind of legal modification that changes the way in which the government can continue to finance its growing fiscal spending. It is like looking for alternatives to finance because it is not enough with what you have, due to mismanagement. The outcome of this is the progressive loss of the bolivar's value, where the Central Bank is increasingly dependent on the political decisions of the Government and more inclined towards an inflationary monetary policy, without any concern for price stability as an objective.
Basically the monetary reforms have had as objective: 1) to enable other sources of fiscal financing in bolivars, 2) to increase the power of the Executive over the monetary authority and 3) accounting relaxations. The beginning of the inflationary spiral that we have today can be identified in the reform of the Central Bank Act of 2005 that creates the FONDEN, whose financing implies both double monetization and the estimate of “el nivel adecuado de las reservas internacionales de la República” [the adequate level of the international reserves of the Republic]. The latter constitutes a discretionary use by the Central Government of resources in foreign currency that would otherwise be part of the country's international reserves, and whose methodology has never been explained, less applied, as various economists have pointed out. Among others, the reformed article 113 of the law legalizes, in short, the origin of the current inflationary crisis of the country.
“… El remanente de divisas obtenidas de la fuente indicada en el presente artículo, será transferido mensualmente al Fondo que el Ejecutivo Nacional creará a los fines del financiamiento de proyectos de inversión en la economía real y en la educación y la salud; el mejoramiento del perfil y saldo de la deuda pública; así como, la atención de situaciones especiales y estratégicas.” ["... The remainder of foreign currency obtained from the source indicated in this article, will be transferred monthly to the Fund that the National Executive will create for the purpose of financing investment projects in the real economy and in education and health; the improvement of the profile and balance of the public debt; as well as the attention of special and strategic situations."]
It also specifies the first transfer that the Central Bank should make to FONDEN of $6B. Until last year the BCV has transferred to the fund more than $50B. PDVSA has also transferred resources to FONDEN, thanks to another infamous legislation lacking economic rationality and that of course contributed in generating the unleashed fiscal and monetary dynamics that we live today.
Four years later, the model based on double monetization and taking of international reserves to finance the treasury showed signs of exhaustion given its lack of wisdom, despite the fact that in 2008 we had soaring oil prices (in June 2008 the average Venezuelan basket arrived at 129.54 $/b). This motivated the government to make another modification to the monetary legislation, whose purpose was similar to that of the previous reform: to open another space for monetary financing of fiscal policy. So that at the end of 2009 another BCV reform is promulgated, where the printing of money to finance the treasury is allowed. The modified and fateful numeral 6 of article 48 of the law:
"Otorgar créditos con garantía de títulos de créditos emitidos por la República o por sus entes descentralizados, así como de instrumentos relacionados con operaciones de legítimo carácter comercial y otros títulos valores cuya adquisición esté permitida a los bancos e instituciones financieras… cuando deriven del financiamiento de programas determinados por el Ejecutivo Nacional como prioritarios para el país…" [To grant loans warranted by securities issued by the Republic or by its decentralized entities, as well as instruments related to operations of legitimate commercial character and other securities whose acquisition is permitted to banks and financial institutions... when derived from the financing of programs determined by the National Executive as priorities for the country...]
And with this begins the growth of inorganic money aimed at government companies. As of 2011, the BCV's financing to PDVSA grew at an average annual rate of 202%, pouring to the money flow the huge amount of Bs.5,6T (up 496% from December 2015) to the end of 2016. Each one of them, inflationary bolivars. Omar Zambrano said at the end of 2013:
"Este instrumento de crédito es la línea más abultada de todas las fuentes de la base monetaria -de hecho equivale a 100% del total del saldo de dinero primario- [a diciembre de 2016 es 103% del dinero base]." [This credit instrument is the heaviest line of all sources of the monetary base - in fact it amounts to 100% of the total primary money balance - [December 2016 is 103% of base money]].
Source: BCV
The reform of 2014 brings with it among other things, the relaxation of the concept of international reserves with the amendment of article 127, and the limitation of the sale of PDVSA's foreign currency to the Central Bank with the reform of article 125, which seeks to have a greater discretion in the use of the flow of resources in foreign currency that the nation receives via oil activity. Another reform that subjugates more the BCV to the Executive Power.
Finally, in 2015 the reform of the BCV Act goes even further in the control over the monetary authority and the lack of transparency. This reform includes among others: a) the appointment of the President and the entire BCV board by the President of the Republic without having to go through the National Assembly, b) the prohibition of publication of data ordered by the Executive, when these "representen una amenaza a la Seguridad Nacional y a la estabilidad económica de la Nación" [pose a threat to the National Security and to the economic stability of the Nation], and c) to grant credits to the Government when there are threats qualified as such by the President of the Republic. In relation to the latter, numeral 2 of article 37 contains the pernicious modification:
"... el Banco Central de Venezuela podrá obtener, otorgar o financiar créditos al Estado y entidades públicas o privadas, cuando objetivamente exista amenaza interna o externa a la seguridad u otro perjuicio al interés público, que calificará el Presidente o Presidenta de la República..." [... the Central Bank of Venezuela may obtain, grant or finance credits to the State and public or private entities, when there is objectively an internal or external threat to security or other damage to the public interest, to be qualified by the President of the Republic...]
In conclusion, if one wishes to explain the monetary policy of chavismo in recent years, reforms to the BCV Act have been fundamental, since they have generated the conditions that put Venezuela at the gates of a hyperinflationary process and that without a doubt have contributed to the current unprecedented crisis of the national economy. In relations to this, Friedman warned of the dangerous effects of negligent monetary policy on the real sector of the economy (1968, p.12).
"But money has one feature that these other machines do not share. Because it is so pervasive, when it gets out of order, it throws a monkey wrench into the operation of all the other machines."
References
Friedman, M. (1968). The Role of Monetary Policy. The American Economic
Review, 58(1), 1-17.
Constitución de la República Bolivariana de Venezuela. (2009, 19 de febrero). Gaceta Oficial Nº 5.908 Extraordinario.
Ley de Reforma Parcial de la Ley del Banco Central de Venezuela. (2005, 20 de julio). Gaceta Oficial Nº 38.232.
Ley de Reforma Parcial de la Ley del Banco Central de Venezuela. (2009, 6 de
noviembre). Gaceta Oficial Nº 39.301.
Ley de Reforma Parcial de la Ley del Banco Central de Venezuela. (2010, 7 de mayo). Gaceta Oficial Nº 39.419.
Ley de Reforma Parcial de la Ley del Banco Central de Venezuela. (2014, 19 de noviembre). Gaceta Oficial Nº 6.155 Extraordinario.
Ley Orgánica de Reforma Parcial de la Ley del Banco Central de Venezuela. (2015, 30 de diciembre). Gaceta Oficial Nº 6.211 Extraordinario.
Montiel, P. (2011). Macroeconomics in Emerging Markets (2da. Ed). Cambridge University Press.
Zambrano, O. (2013). ¿Qué es lo peor de nuestra mala política monetaria? [Blog post]. Obtained from http://distortioland.blogspot.com/2013/11/que-es-lo-peor-de-nuestra-mala-politica.html.
