Exploring Of Policy Responses To The Inflation - Venezuela And Zimbabwe

Abstract:

This article studies the possible policy responses a government can give to the inflation happened in the country. In specific, this article will first talk about both the cost-push and demand-pull inflation, using example of Venezuela’s great inflation in 2018 and Zimbabwe’s inflation in 2008. After identifying the problem and causes to Venezuela’s inflation, this article will talk about the possible solutions, which come from Fiscal Policy and Monetary Policy sides, and both positive and negative possible results of them.

Introduction:

Inflation is defined as a persistent increase in the average price level in the economy. Aggregate Demand is the willingness and the ability people have to consume goods and services. Short Run Aggregate Supply is the total amount of output made by producing goods and services in a short period of time. There are two different types of inflation in the economy. One is called cost-push inflation, the other is called demand-pull inflation. Diagram 3 shown above illustrate both demand-pull inflation and cost-push inflation. The demand-pull inflation occurs because a increase in aggregate demand in the economy. As shown in Diagram 3, the increase in Aggregate Demand causes the price level to increase: the price increase from P to P1, which, by the definition of inflation, can be defined as inflation. The cost-push inflation is caused by the decrease in aggregate supply in the economy. As shown in Diagram 3, the SRAS (Short Run Aggregate Supply) decreased from Y1 to Y2, which causes the average price level to increase from P1 to P2. Therefore, cost-push inflation occurs.

Fiscal Policy involves the government changing tax and spending levels in order to influence the level of aggregate demand. Monetary policy is the central bank use policies that control the interest rate and money supply. Both Fiscal Policy and Monetary Policy are effective in controlling the inflation rate. To reduce the demand-pull Inflation, the government can increase tax, such as income tax, so people will have less income to spend (Aggregate Demand decreases), and reduce government spending, which causes less growth in the economy. The Monetary Policy can reduce the inflation in the economy by decreasing the money supply and increase the interest rate. Rather than directly reduce the supply of the money, the central bank can restrict the amount of money banks can lend. Also, it can higher the interest rate so people will be less willing to loan since it is expensive and the spending will decrease.

Venezuela’s Problem and Causes of it:

Venezuela is experiencing a high rate of inflation in its country. The rate of inflation began to accelerate significantly in August and faces no obstacles to keep rising even higher in 2018 because the regime of President Nicolás Maduro seems likely to continue printing money since it lacks the cash needed to finance operations. This inflation involves both the demand-pull and cost-push inflation. The demand-pull inflation was caused by the increases in Short Run Aggregate Demand. From the article “Devastating forecast: Venezuelan inflation could reach 30,000 percent, economists say”, it says that “buying power of Venezuelans could drop by 50 percent from one month to another, and by 75 percent in just eight weeks. ” Because the buying power can decrease, people are willing to use their money as quickly as they can. Therefore, the short run aggregate demand will increase enormously and cause the average price level to increase. Thus, cause a demand-push inflation to the society, which now is 30000 percent in Venezuela according to the article. However, such great inflation in Venezuela cannot be caused by demand its own, it is also a cost-push inflation. When the average price level is now so high, the firms will experience more cost if they want to produce the same amount of goods since the price of the raw materials they need increase. Also, since the average price level has increased, the workers will have to pay more to buy other goods and services. Therefore, the workers will negotiate for a higher wage with the company, which cause the cost for the firms to further increase. As a result, a firm will not be willing to produce so many goods in such high cost since the revenue is so low. Thus, it will decrease its supply. Therefore, the Aggregate Supply in the country will drop dramatically. Thus, cause the inflation to occur.

Zimbabwe’s Problem and Causes of it:

Following a controversial land reform involving the expropriation of the properties of white landowners in the late 1990s, Zimbabwe experienced a sharp agricultural decline. The situation was made worse by a costly involvement in the Congo War in 1998 and the effects of US and European sanctions against Robert Mugabe's government in 2002. As the decade rolled on, prices began to rise. By November 2008, inflation had reached 79,000,000,000% a month. Shops increased prices several times a day. The collapsing economy meant people had to live with frequent water and power-cuts, queues at banks and petrol stations, and severe shortages of food in supermarkets. Many crossed into South Africa or Botswana to buy basic goods, and the US dollar and the South African rand became de facto currencies. In 2009, the Reserve Bank of Zimbabwe abandoned its currency and adopted the US dollar and the South African rand as the main means of exchange.