Money and Banking
Money, Banks, Monetary Policy
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Case Study
The Demise of Venezuela Bolivar
Price stability is the most important goal of central banks in modern countries. However, central banks in some developing countries fail to maintain the price stability target due to political and economic reasons, leading to disastrous outcomes. Venezuela, despite being the strongest economy in the 1970s, is also facing such a problem.
Source A: A Brief History of Venezuela Bolivar
Source A: A Brief History of Venezuela Bolivar
The Venezuelan bolĂvar is the official currency of Venezuela. Due to its decade-long reliance on silver and gold standards, and then on a peg to the United States dollar, it was considered among the most stable currencies and was internationally accepted until 1983, when the government decided to adopt a floating exchange rate instead. Since 1983, the currency has experienced a prolonged period of high inflation, losing value almost 500-fold against the US dollar in the process.
Source B: Domestic Price of Daily Necessities
Source B: Domestic Price of Daily Necessities
In August 2018, the price of a 2kg chicken (top left) was worth 14,600,000 bolivars. The price of 1kg of rice (top right) was worth 2,500,000 bolivars. The price of a package of diapers (bottom left) was worth 8,000,000 bolivars. The price of a roll of toilet paper (bottom right) was worth 2,600,000 bolivars.
Source C: 1st Redenomination of the Bolivar
Source C: 1st Redenomination of the Bolivar
Redenomination is the process of changing the face value of banknotes and coins in circulation. The Central Bank of Venezuela adopted a redenomination on August 20, 2018. 100,000 Bolivars (VEF) were exchanged for 1 new currency Sovereign Bolivar (VES).
Source D: Venezuela Inflation Rate
Source D: Venezuela Inflation Rate
Hyperinflation is defined as the inflation rate of a country increasing by 50% over a year. Venezuela has been experiencing hyperinflation since 2014.
Source E: Money Supply in Venezuela between 2012 and 2018
Source E: Money Supply in Venezuela between 2012 and 2018
Potential depositors have little incentive to make deposits given massively negative interest rates. In November 2018, the highest interest-paying bank deposit, term deposits, paid an average interest of just 14.5%. At the same time, the weighted average lending rate stands at 22%. With monthly inflation well over 50% a month, the demand for loans is inexhaustible, but the bank's capacity to make loans has not kept up.
POINT TO DISCUSS:
What was the legal tender of Venezuela in 2018 and 2019 respectively?
Hint: Recall the definition of legal tender and read the case carefully.
Hints and Related Concepts
Related Concepts:
Which property/properties of money did Bolivar violate? Explain.
Hint: Recall the five properties of money.
Hints and Related Concepts
Related Concepts:
Which function(s) of money did Bolivar serve? Explain.
Hint: Recall the four functions of money.
Hints and Related Concepts
Related Concepts:
Suggest some possible reasons for the high proportion of M1 in Venezuela's M2. Explain.
Hint: Recall the definition of money supply. You may think from depositors' side and banking's side. Also, you may think about the relationship between interest rate and inflation rate.
Hints and Related Concepts
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