Julián Andres Prieto Venegas

Public Choice (2021) 186:337–350

Cód. 1103874
https://doi.org/10.1007/s11127-019-00766-5 Economía - Grupo CIVB

The political economy of hyperinflation in Venezuela

Giovanni B. Pittaluga1 · Elena Seghezza2 · Pierluigi Morelli3

Received: 1 September 2019 / Accepted: 5 December 2019 / Published online: 3 January 2020
© Springer Science+Business Media, LLC, part of Springer Nature 2020

Abstract
We study the Venezuelan hyperinflation as a political phenomenon with distributional
and efficiency effects. The hyperinflation originated in publicly financed benefits for the
government’s low-income supporters and also had a distributional effect in wiping out the
value of bonds and other financial assets of the middle and upper classes that opposed the
government. We confirm the fiscal origin of the hyperinflation and also show that, with
the inflation tax as the government’s principal source of supplementary revenue, policy
managers did not avoid moving to the inefficient side of the Laffer curve. The rate of
infla- tion exceeded Cagan’s revenue-maximizing inflation tax rate and therefore also
Bailey’s efficient inflation tax rate.

Keywords Hyperinflation · Venezuela · Political redistribution · Thiers’ law

JEL Classification E31 · E41 · E65

1 Introduction

Hyperinflations have been studied as macroeconomic phenomena with a view to under-

standing how the inflation episode began, the path of price increases, and how inflationary
processes came to an end (Siklos 1995; Bernholz 2015). We study the Venezuelan
hyperin- flation of the early twenty-first century as a political phenomenon with
distributional inten- tions and efficiency consequences. The socialist or populist
government, initially elected to office in 1998, implemented social policies financed by
public spending to provide benefits to a supportive low-income constituency. When,
because of a decline in oil-related rev- enue, the financing of the existing level of public
spending no longer could be sustained by

 Elena Seghezza
seghezza@unige.it
Giovanni B. Pittaluga
pittagb@unige.it
Pierluigi Morelli
p.morelli@abi.it
1
Department of Economics, University of Genova, Via Vivaldi 5, 16126 Genoa, Italy
2
Department of Political Science, University of Genova, P.le Brignole 3, 16125 Genoa, Italy
3
Associazione Bancaria Italiana, P.zza del Gesù 49, 00186 Rome, Italy

13
33 Public Choice (2021) 186:337–350

domestic and oil-related tax bases, inflationary financing was adopted and hyperinflation
ensued. The hyperinflation destroyed the wealth of the middle and upper classes, primarily
the owners of bonds and other unlinked financial assets, which opposed the government.
The government’s supporters gained and the opponents of the government lost.
Efficiency consequences likewise emerged. Seigniorage (an inflation tax) is a source of
revenue or resources for the government budget. The Venezuelan government, in seeking
to finance its spending, might wish to have chosen the seigniorage-maximizing rate of
infla- tion, which is the inflation tax at the maximum of the Laffer curve, as derived by
Cagan (1956). The choice of the seigniorage-maximizing inflation-tax rate is consistent
with a revenue-maximizing Leviathan government (Brennan and Buchanan 1980, 1981).
Bailey (1956) derived the inflation tax as a component of the efficient structure of taxation
as determined by the Ramsey rule. The efficient Bailey inflation tax is less than the
seignior- age-maximizing inflation tax of Cagan. We show empirically that, after a certain
point in time, the rate of inflation exceeded the seigniorage-maximizing rate, implying that
inflation also exceeded the Bailey efficient inflation tax. The government therefore was on
the inef- ficient side of the inflation-tax Laffer curve. Distributional objectives and
efficiency often conflict (Hillman 2019, chapter 7). Revenue raised for redistribution
purposes financed by a tax that creates efficiency losses is a usual instance of the conflict.
Inefficiency is a social cost of redistribution. When a tax is on the wrong (downward) side
of the Laffer curve, inefficiency is ‘excessive’. In the case of the inflation tax in
Venezuela, more seigniorage would have been collected at a lower rate of inflation.
We proceed in Sect. 2 briefly to summarize the development of hyperinflation in Ven-
ezuela and we consider the alternative explanations of hyperinflation as having origins in
domestic fiscal policy or the balance of payments. In Sect. 3, we describe the social poli-
cies that required new sources of public finance and identify the redistributional conse-
quences of the government’s policies. In Sect. 4, we make the case that the hyperinflation
had origins in fiscal policy rather than originating in Venezuela’s balance of payments.
Section 5 considers the efficiency of the inflation tax. We estimate a demand-for-money
function. In our estimates, we account for Thiers’ law (Bernholz 1989), which states that,
when inflation materializes, the demand for money is affected by substitution to foreign
currency and assets. Although financial markets were repressed, opportunities for currency
and asset substitution were present. Such substitution reduces revenue from the inflation
tax. We show that the inflation tax was on the inefficient side of the Laffer curve. Conclu-
sions are summarized in the final section.

2 Hyperinflation in Venezuela

Countries in Latin America frequently have experienced episodes of hyperinflation (see

Phylaktis and Taylor 1993). The episodes have been attributed to political instability (Pal-
dam 1987) and populist regimes (Dornbusch and Edwards 1991). A populist or socialist
government was elected to office in Venezuela in 1998. Table 1 shows that, for much of
the subsequent decade, “chronic” inflation became “hyperinflation”. Starting in July 2015,
annualized inflation exceeded 100% and in October 2017 surpassed the rate of 50% per
month, which, using the Cagan (1956) definition, is hyperinflation. By the end of 2017,
the annual inflation rate was 2585% (for more details, see Restuccia 2018).
The acceleration of inflation was associated with a remarkable expansion of real money
balances. Those balances started to decline only when inflation became explosive (Fig. 1).

1
 Public Choice (2021) 186:337–350
Table 1 Bolivarian Republic of Venezuela: economic indicators

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

Real GDP growth 4.8 – 3.3 – 1.5 4.2 5.5 1.3 – 3.9 – 6.2 – 16.6 – 14.0
Inflation1 30.9 25.1 27.2 27.6 20.1 56.1 68.5 180.9 274.4 2585.8
M2 growth (%) 28.8 33.2 28.6 32.7 43.6 54.3 66.0 97.7 163.6 1121.4
M2 growth in real terms (%) 191.2 186.8 185.1 219.3 293.8 318.0 312.0 219.6 154.6 70.3
GDP/M2 3.54 3.02 3.45 3.05 2.28 1.86 1.51 1.52 2.70 2.01
Government revenue2 31.4 24.6 21.2 27.9 25.1 28.1 30.3 19.2 14.7 14.5
Government expenditure2 31.9 29.3 30.2 37.9 37.3 35.0 42.7 35.0 34.1 40.6
Budget balance2 – 0.3 – 4.7 – 9.0 – 10.0 – 12.2 – 6.9 – 12.4 – 25.8 – 19.4 – 26.1
Government debt2 14.0 18.2 29.0 25.1 27.5 32.9 28.5 29.6 N.a. N.a.
Domestic 4.5 7.5 14.0 11.3 15.6 20.1 19.5 22.2 N.a. N.a.
External 9.5 10.7 14.9 13.7 11.9 12.8 9.0 7.3 N.a. N.a.
Current account balance2 12.0 2.6 4.9 8.2 3.7 2.0 1.4 – 6.6 – 1.6 2.0
Capital and financial balance2 – 22.2 – 10.7 – 13.6 – 20.4 – 3.6 – 9.2 – 4.3 14.6 N.a. N.a.
Foreign reserves (mln. $) 33,098 21,703 13,137 9930 9900 6038 7457 6324 3265 1931
External debt on export (%) 62.9 134.3 144.4 121.0 128.3 142.0 172.7 313.2 385.9 N.a.

Source: IMF—Regional Economic Outlook Database, and World Bank, International Debt Statistics. 1Annual values in percentages. 2In percent of GDP. Unavailable data are
indicated by the abbreviation n.a
1

3
 3 Public Choice (2021) 186:337–350

1.6
12
1.4
11
1.2
10
1.0
9
0.8
8
0.6
7
0.4
6
0.2
5
0.0
4
2012 2013 2014 2015 2016 2017

Fig. 1 Real monetary balances and the consumer price index

Bernholz (2003, pp. 114–115) compares the pattern of the real money balances in episodes
of hyperinflation with Gresham’s law first and then, when inflation is particularly high,
with Thiers’s law.
An explanation of the origin of Venezuelan hyperinflation reduces to an explanation
of the causes of the extraordinary growth of the money supply that began in 2012. As is
known, two explanations of the origins of hyperinflation are possible: the fiscal view and
the balance of payments view. In the fiscal view, fiscal deficits drive excess money crea-
tion. As shown by Sargent and Wallace (1981), the continuous expansion of the monetary
base arises from persistent fiscal disequilibria. In that view, therefore, as Bernholz (2003,
p. 110) observed: “Hyperinflations are always caused by public deficits which are largely
financed by money creation.” Therefore, the causal chain in the fiscal view goes from
money growth to the increase in prices and then to depreciation in the exchange rate. In
the “balance of payments view”, inflation comes about from an exchange rate crisis caused
by persistent disequilibria in current account balances (Krugman 1979), by self-fulfilling
expectations (Obstfeld 1986), or by a sudden stop in capital inflows (Calvo 2012). A
depre- ciating exchange rate leads to an increase in prices associated with growth in the
money base. The causal chain is that depreciation of the exchange rate results in price
increases, which results in money growth (see, among others, Leviathan and Piterman
1986; Kiguel and Liviatan 1988; Montiel 1989). We shall return to those alternative
explanations for the Venezuelan hyperinflation. First we describe the social policies that
required raising public spending.

3 The politics of public spending

3.1 Policy benefits for political supporters

The rate of inflation accelerated for the first time in 2013. The acceleration followed a sig-
nificant increase in the growth of money the previous year (Table 1). The public sector’s
primary deficit increased from 9.0 to 12.2% of GDP between 2010 and 2012. In the run-up
to the presidential election of October 2012, President Hugo Chavez oversaw an extraordi-
nary rise in public spending (see Vera 2015). Social policies targeting low-income voters

1
 Public Choice (2021) 186:337–350 3
necessitated large increases in current budgetary outlays1. In 2011, pension rights were
extended to all citizens, regardless of whether pension-fund contributions had been made.
As a result of that policy (called the Gran Misiòn en Amor Major—Grand Mission Love
for Elders), the number of pensioners increased to almost two million from some 500,000
ten years earlier. In the same year, President Chavez decreed a further expansion of
govern- ment spending in the form of other three missions. The missions were continued
by his successor Maduro.

•
The Gran Misiòn Vivienda (Grand Mission in Housing) decreed the building of hun-
dreds of thousands of houses to be assigned to inhabitants of the ranchos (urban
slums);
•
The Gran Misiòn Sober y Travajo (Grand Mission of Knowledge and Work) decreed
that the government would create new jobs involving training programs for the unem-
ployed or underemployed;
•
The Gran Misiòn Hijos del Venezuela (Grand Mission for Sons of Venezuela) was to
provide income for the poorest families.

Implementation of the ‘Missions’ was the responsibility of the Unified Social Fund,
which was under the control of the armed forces, thereby reinforcing their involvement in
the regime (Corrales and Penfold 2011). In another policy measure, in 2012 the govern-
ment increased the minimum monthly wage and pensions by 32.25%, a rate exceeding the
then-current rise in consumer prices.

3.2 Financing of the public spending

Between 2010 and 2012, the exceptional increase in public spending required by the above
policies could be financed by an oil-price windfall channeled through the state-owned
PDVSA (Petróleos de Venezuela S.A.). That source of public finance is difficult to
quantify because, as often happens in politically opportunist or mal-administered countries
rich in natural resources, accountability regarding the use of profits is inadequate (see
McGuirk 2013). Government revenue from oil exports and new debt issues provided
financing for the additional public spending. Also, in January 2011, the exchange rate
was devalued in order to increase the domestic value of foreign-currency reserves (see
Kulesza 2017). The expansion of public spending implemented between 2010 and 2012
was accom- panied by an acceleration in money creation, the annual growth rate of
which rose from
28.6 to 43.6%. The acceleration of money growth predictably was followed by an increase
in prices: between 2012 and 2013, the inflation rate rose from 20.1 to 56.1% (Table 1).
Expansionary fiscal policy helped revive GDP growth and contributed to Chavez winning
another presidential election and consolidating his political alliance with the military (see
Leon 2014). In mid-2014, a fall in the world price of oil reduced government revenue but
the government did not cut public spending. The decline in revenue and the sustained pub-
lic spending increased the budget deficit, which was financed by money creation and
result- ing hyperinflation. Between 2014 and 2017, the annual growth of M2 rose
markedly and the price level increased significantly (Table 1).

1
 3 Public Choice (2021) 186:337–350
1
In populist regimes, this type of expense is paramount. See Pittaluga and Seghezza (2018).

1
 Public Choice (2021) 186:337–350 3
3.3 Redistribution

Through inflationary financing, the government could maintain public spending in favor
of the regime’s supporters. Resources were transferred away from the middle and upper
classes opposing the regime, whose nominally denominated government bonds declined in
real value. Financial markets were repressed. Capital outflows were restricted. In 2018, the
annual nominal interest rate on domestic public debt was close to 45% while monthly
infla- tion was significantly above 50%. As shown in Table 1, in 2012 the ratio of
domestic debt to GDP was relatively contained in comparison with that of foreign debt to
GDP. Reinhart and Santos (2015) show that in 2013 the reduction in purchases of
domestic debt owing to the inflationary erosion of its market value amounted to 5% of
GDP, which increased substantially when inflation accelerated and, a fortiori, when
inflation became explosive. In 2018, the highest interest-bearing bank deposit returned an
average of 14.5%.

4 The origin of hyperinflation

4.1 The balance of payments

We return now to the two alternative views of the origins of hyperinflation. The events
described in Sect. 3 of redistribution through fiscal policy and the need for financing of
public spending when oil-related government revenue declined suggest a fiscal
explanation for the Venezuelan hyperinflation rather than originating in a balance-of-
payments crisis. The current account balance, although worsening, remained positive until
2014 (Table 1). Given the continued availability of foreign currency reserves in 2014, a
crawling peg exchange-rate regime could be maintained with an official exchange rate
misaligned with that of the parallel or ‘black’ market. The official exchange rate was
devalued only at long intervals of time (Kulesza 2017). The overvalued currency
supported low-cost imports, especially food, and penalized exporters, contributing to
worsening of the balance of pay- ments.2 Rising deficits in the balance of payments were
covered by official foreign cur- rency reserves, the amount of which in consequence
declined (Table 1).3

4.2 Causality tests

We carried out causality tests to ask whether excessive money supply growth caused infla-
tion or, instead, whether hyperinflation was triggered by exchange-rate depreciation, as
proposed by the balance of payments view. We follow others (for example, Montiel 1989;

2
The acceleration in the inflation rate that occurred between 2013 and 2017 was accompanied by contin-
ual depreciation of the Venezuelan currency, the bolivar, on the black market. Such an exchange rate trend
highlights an empirical regularity that Paldam (1994) called “Bernholz’s Law”. Initially, the black market
value of the bolivar depreciated in real terms and then began to appreciate in early 2016 when the inflation
rate became explosive. See Bernholz (1982, 1988).
3
The gradual but marked depreciation of the nominal official rate of exchange was accompanied by a
substantial increase in the equivalent bolivar value of foreign debt. As shown in Table 1, the ratio of for-
eign debt to exports between 2013 and 2016 (latest data available) increased from 142.0 to 385.9%. Much
of Venezuela’s foreign debt belongs to state-owned PDVSA. Default on that debt is problematic because

1
 3 Public Choice (2021) 186:337–350
PDVSA has to obtain the necessary funding for oil production on the foreign financial market.

1
 Public Choice (2021) 186:337–350 3
Table 2 VAR Granger causality/block exogeneity Wald test (2013.01–2017.12; included observations: 58)

Inflation rate Real M2 Real official

exchange rate

Excluded variables Chi-sq Prob. Chi-sq Prob. Chi-sq Prob.

Real M2 31.1 0.00 – – 8.1 0.02
Real official exchange rate 3.6 0.16 2.5 0.28 – –
Inflation rate – – 32.0 0.00 28.9 0.00
All 37.3 0.00 47.2 0.00 31.5 0.00

Table 3 Composition of forecast

error variance for inflation in Months Inflation Real M2 Real official S.E.
Venezuela (in percent) exchange rate

A: ordering: inflation— M2—real official exchange rate

real
6 71.7 27.9 0.4 0.2
12 24.9 74.5 0.6 0.5
24 4.5 95.3 0.2 1.9
B: ordering: real M2—real official exchange rate—inflation
6 93.4 2.7 0.9 0.2
12 69.8 30.0 0.4 0.5
24 20.8 78.9 0.2 1.9
C: ordering: real official exchange rate—real M2—inflation
6 96.4 2.8 0.8 0.2
12 69.6 30.2 0.2 0.5
24 20.8 78.6 0.6 1.9

Dornbusch et al. 1990; Fischer et al. 2002) in using a VAR Granger causality method-
ology, with three variables: the annual inflation rate, annual changes in the real official
exchange rate and real M2.4 The data consist of time series from 2013.01 to 2017.12. From
the results of the Granger causality tests reported in column (1) of Table 2, the null
hypoth- esis—the variable of interest does not cause inflation—is rejected for real M2,
while it can- not be rejected for the real exchange rate.5
The empirical evidence in Table 2 points to hyperinflation being triggered and fueled
by an extremely loose monetary policy. We can surmize that Venezuela’s inflationary
mon- etary policy originated in the need to cover growing fiscal deficits.
From Table 2, it also emerges that the inflation rate influenced variations in the real
exchange rate. The indication is that excessive money creation triggered a pronounced
acceleration in price growth, which was reflected in the depreciation of the real exchange
rate. That evidence is consistent with the fiscal hypothesis.

4
As in Montiel (1989) and in Fischer et al. (2002). Dornbusch et al. (1990), instead, used the real mon-
etary base as a proxy for real fiscal deficits.
5
The null hypothesis is rejected at a level of probability below 0.05.

1
 3 Public Choice (2021) 186:337–350

Table 4 Seigniorage in Venezuela in the 2010–2017 period

(Bmt − Bmt−1 ) Inflation tax Seigniorage Seignior-

(ṗ t Bmt−1 ) S = ṗ t Bmt−1 + Bmt Bmt−1 age/Gov.
− exp.

2012 36,140 20,570 56,720 15.7

2013 9720 57,310 67,030 19.6
2014 1900 68,650 70,560 17.6
2015 – 42,370 110,000 67,630 21.9
2016 – 13,150 94,140 80,980 36.6
2017 – 36,430 111,000 74,570 33.0

Bmt is the monetary base in real terms and ṗ t = Pt −Pt−1 is the inflation rate; values in thousands of bolivar
t

except in the last column percentage. Source: CEPALPStatistics

To assess the fiscal hypothesis further, we use the variance decomposition of the VAR
system.6 Table 3 shows that, whatever the ordering of variables, the change in real M2
explains a substantial share of the inflation forecast error variance, while the change in the
real official exchange rate accounts for a negligible fraction of that variance.

5 The inflation tax

5.1 The evolution of seigniorage

We consider now the inflation tax. We can determine the amount of seigniorage S, its
share in covering public spending and changes in its composition over time. Indicating by
BMt the monetary base at time t, seigniorage is:
BMt − BMt−1 BMt BMt−1 BMt BMt−1 Pt−1
S = = − = − . (1)
t
Pt Pt Pt Pt Pt−1 Pt

Defining the real monetary base as −Pt−1

Bmt = BMt
t
and inflation as ṗ = Pt
t
, Eq. (1) can be
P t P
written as:

St = Bmt − 1 − ṗ t Bmt−1 = ṗ t Bmt−1 + Bmt − (2)

Bmt−1

Equation (2) shows two distinct sources of seigniorage. The first is represented by ṗ t
Bmt−1, that is, by the inflation tax that private individuals pay the government for holding
the mon- etary base, that is, money in circulation plus bank reserves. The second source of
seignior- age stems from the desire of private individuals to change their real money
holdings given the inflation rate. Taking into account Eq. (2), we estimated the amount of
seigniorage dur- ing the acceleration and early hyperinflation episode in Venezuela (Table
4). Table 4 shows that the components of seigniorage changed over time: real monetary
balances held by private

1
 Public Choice (2021) 186:337–350 3
6
The function shows how much of the prediction error of each variable can be explained by innovations in
the variable under consideration.

1
 3 Public Choice (2021) 186:337–350

individuals declined, while revenue from the inflation tax increased. From 2017, the
reduction in the demand for real money balances was more pronounced than the increase in
the revenue from the inflation tax.

5.2 The Cagan and Bailey inflation taxes

The demand for real money can be specified as (see Cagan 1956; Sargent and Wallace 1973):
mt − pt = 𝛼ṗ e
+ vt (3)
t
,
where m is the logarithm of money and p that of the price level,ṗ e is expected inflation
and vt is a stationary error term. On the basis of Eq. (3) and the assumption
t
of a constant
semi-elasticity of money demand with respect to inflation, Cagan (1956) concluded that
the seigniorage-maximizing inflation rate is given by ṗ ∗ = 1 where is the coefficient
of Mt αлe
𝛼
expected ̇ inflation.
̇
In levels, Eq. (3) is Pt = e t+1. In the steady state, seigniorage is given
̇
M M M M
by S = P
= M P
. Since in the steady state the growth rate of money, M , is equal to the rate
at which nominal money holdings lose real value, i.e., л seigniorage is S = л M. Substitut-
ing Eq. (3) into the formula for seigniorage, we can calculate 6S = eαл (1 + αл).P Equating
6S
= 0, we obtain the inflation rate ṗ ∗ = 1 that maximize seigni6oлrage.
6 Bailey (1956) viewed inflation as one of � many taxes with efficiency losses. A welfare-

maximizing government collects taxes efficiently by adopting the Ramsey rule: since
infla- tion is a tax, the government equates the marginal cost of raising revenue by other
taxes µ to the marginal cost of raising revenue through seigniorage. The welfare-
maximizing ∗∗ infla-
tion tax is p = µ
.7 It is evident that, if taxes generate efficiency losses so that μ > 0,
α(1+µ)
Cagan’s seigniorage-maximizing inflation rate of ṗ ∗ = 1 exceeds Bailey’s efficient inflation
�
tax of ṗ ∗∗.

5.3 Thiers’s law

Thiers’s Law (Bernholz 1989, 2003) is the propensity of individuals in hyperinflations to

substitute domestic currency for foreign currency and assets. When it operates, Thiers’s
law reduces the inflation rates specified according to Cagan and Bailey. Determination of
ṗ ∗ and ṗ ∗∗ requires the estimation of a money demand equation. As indicated in Eq. (3), in
Cagan (1956), during hyperinflation episodes, money can be substituted only by goods
(see
Dornbusch et al. 1990). Where possible, domestic money is substitutable not only by
goods but also by foreign currency and financial assets. Following Abel et al. (1979) and
Taylor (1991), we modify Eq. (3) by taking account of the expected exchange rate
depreciation,
ṡ e . The demand for money then becomes:
t+1

7 6W∕6л
The marginal cost of raising revenue through seigniorage is given by , where W is the welfare loss
6S
from inflation and is the area under the money demand curve. The ratio 6W∕6л is the marginal cost of infla-
6S
tionary finance, which simplifies to 6W∕6S, that is, to the marginal welfare cost associated with a unit
increase in seigniorage. Following Bailey (1956), W = ∫ л (e−αx − e−αл )dx, which leads to
0

1
 Public Choice (2021) 186:337–350 3
W = −e−αл 1 + л + 1. The first derivative of W with respect to inflation is 6W
= e−aлα 1
+л − e−αл.
α α 6л α
Therefore, the marginal cost of inflationary finance is 6 W ∕6 л
= αл
. Then, equating the marginal cost of
6S∕6л 1−αл αл
inflationary finance to the marginal cost of raising money through the inflation tax, i.e., 1 αл = µ, we obtain
welfare-maximizing inflation tax p∗∗ = µ . −

α(1

1
 3 Public Choice (2021) 186:337–350

Table 5 Bai-Perron multiple

breakpoint tests for the expected F-stat Bai-Perron
exchange rate (2013.01–2017.12) critical value

Sequential F-stat determined breaks: 2

Break test
0 versus 1 141,22* 8,58
1 versus 2 28,52* 10,13
2 versus 3 4,2 11,14
Break dates
1 2015.06
2 2016.04
*Significant at 5% level

(m − p)t = 𝛼ṗ e + 𝛽ṡ e + 𝜁t .

(4)
t
t
As in Taylor (1991; see also Abel et al. 1979), we assume that the inflation forecasting
error is stationary.8 Therefore, Eq. (4) becomes:
(m − p)t = 𝛼ṗ t+1 + 𝛽ṡ e + 𝜂t ,
(5)
t
where ηt = (t − α ft+1 . On the basis of Eq. (5), Cagan’s seigniorage-maximizing inflation
becomes 1 . Assuming for simplicity, on the basis of the purchasing power parity prin-
dṗ

ciple, that ∝dṡ

+ ∕dṗ = 1, then by Thiers’s law, the seigniorage-maximizing inflation rate
derived from Eq. (5) is less than that derived from Eq. (3).

5.4 Estimates

With data for the forward exchange rate not being available for Venezuela, to estimate (5),
we used the difference between the parallel and the official exchange rate of the bolivar as
a proxy for the premium/discount on the current exchange rate. That differential can be
interpreted as the opportunity cost of holding domestic money since, given constraints on
capital flight from Venezuela, substituting domestic currency for foreign currency
occurred primarily through the over-invoicing of imports (see Reinhart and Santos 2015).
For the monetary aggregate, we used the broad aggregate of money M2 9 and for prices we
used consumer prices.10 The estimation period is from January 2013 to December 2017.
The sample was not extended to 2018 because of the absence of reliable data.
The tipping point from inflation to hyperinflation in Venezuela was preceded by a
period of progressive acceleration of price growth. Within the relevant period, changes in
exchange rate expectations can be identified. In order to identify the break points related to
those changes, the multiple breakpoint test of Bai and Perron (1998) was adopted. The
results of the test are shown in Table 5. From the latter, it emerges that in the time period
considered, that is 2013.01–2017.12, two break points can be identified in exchange-rate
expectations, namely 2015.06 and 2016.04. On the basis of that evidence we can
distinguish three phases.

8
That is, pt+1 = pe + st+1 where ε is a stationary process.
t+1
9
In the case of Venezuela, M2 coincides substantially with M3.
10
Although we are aware that for various goods prices were capped and therefore that the indicator under-
estimates Venezuela’s inflation, it is such variation that constitutes the opportunity cost of holding money.

1
 Public Choice (2021) 186:337–350 3
Table 6 Unit root tests
ADF test Phillips–Perron Test
t-statistic Prob. t-statistic Prob.

Real broad money, mt − pt Level – 1.51 0.12 – 1.66 0.09

First difference – 4.05 0.00 – 3.88 0.00
Inflation, ṗ t Level 3.37 0.99 4.91 1.00
First difference – 2.09 0.04 – 2.08 0.04
Forward premium, ṡ e Level 5.16 1.00 4.52 1.00
First difference – 1.60 0.10 – 5.69 0.00

The null hypothesis is that the variable has a unit root

Table 7 Cointegration analysis: dependent variable real money

Col. (1) Col. (2) Col. (3) Col. (4)

Constant 1.572***
(0.074) 1.772*** 1.410*** 1.698***
ṗ − 5.075*** (0.113) (0.046) (0.054)
t
(0.757) – 3.405** – 1.269*** – 2.968***
ṡ e (1.363) (0.408) (0.673)
t – 0.093*
(0.050)
ṡ e*Phase1 − 0.031 − 0.008
t (0.021) (0.035)
ṡ e*Phase2 − 0.026* – 0.048**
t
(0.015) (0.024)
ṡ e*Phase3 − 0.109*** – 0.117***
t
(0.015) (0.025)
Adj. R2 0.80 0.85 0.98
Sample period: 2013.01-2017.12
No. obs. 60
Estimation method DOLS DOLS DOLS VECM

Standard errors in parentheses; ***significant at 1% level; **significant at 5% level; *significant at 1%

level

Phase 1 corresponds to the period from January 2013 to May 2015; Phase 2, between June
2015 and March 2016; Phase 3, between April 2016 and December 2017.
The method used in the estimate is cointegration. If, as assumed, the inflation fore-
casting error is stationary, the residuals of Eq. (5) must be I(0). Therefore, real money,
inflation and the forward premium must be cointegrated. The estimation of the cointe-
grating equation was preceded by unit root tests for broad money in real terms, m − p
expressed in logarithms, the inflation rate, ṗ , and the forward premium, ṡ e On the basis
of the ADF and Phillip–Perron tests, it could be concluded that all the variables are
integrated of order one (Table 6).
We proceeded to the cointegration estimates by dynamic ordinary least squares
(DOLS). The results of the cointegrating regressions are reported in Table 7.
The first column shows a Cagan-type regression in which the demand for real money

1
 3 Public Choice (2021) 186:337–350
depends solely on the expected rate of inflation. As expected, the latter variable proves

1
 Public Choice (2021) 186:337–350 3
Table 8 Engle Granger and Col. (1) Col. (2) Col. (3)
Phillips–Ouliaris cointegration

tests – 1.44 – 2.19 – 4.69**

Engle Granger tau-statistics1
Engle Granger z-statistics1 – 10.47 – 9.63 – 79.98***
Phillips-Ouliaris tau-statistics1 – 1.22 – 1.86 – 4.57*
Phillips-Ouliaris z-statistics1 – 5.07 – 6.84 – 33.21**
Null hypothesis: Series are not cointegrated; Rejected at ***1%;
**5%; *10% level

Table 9 Johansen cointegration

tests Number of cointegrating Trace test Maximum
vectors eigenvalues
test

None 83.41*** 39.22***

At most one 44.18 27.46*

***significant at 1% level; *significant at 1% level

significant and has a negative sign. Nevertheless, on the basis both of the Engle–Granger
and the Phillips–Ouliaris test, real money and inflation are not cointegrated (Table 8).
The extent of cointegration increases if the forward premium is taken into account,
that is to say, by estimating Eq. (5). The results of that estimation, given in the second
column of Table 7, show that the forward discount (premium) had a negative (posi-
tive) influence on the demand for money: however, that equation is not cointegrated
(Table 8).
In the estimates of column (3) and (4) we take into account the three phases of inflation
identified by dummies. That specification allows us to establish if and how, in the
different phases, the behavior of private individuals changed in relation to their
expectations regard- ing exchange rate depreciation.
Column (3) shows that the coefficient of the expected exchange rate is negative and
significant, and different for phases 2 and 3, while it is not significant for phase 1. Once
the phases of inflation are taken into account, the equation passes all cointegration tests
(Table 8). Moreover, as highlighted by the coefficient of the variable in Phases 2 and 3,
Thiers’s effect tends to be accentuated when the inflation rate is higher.
Column (4) reports a robustness test by changing the method of estimation to the
Vector Error Correction (VEC) method instead of DOLS. The estimate yields results
similar to those in column (3) and passes the cointegration tests (Table 9).
Using the estimated equations, we can determine the level and pattern of what in the
Cagan or Bailey analysis is the optimal inflation rate. In particular, taking as a reference
column (3) in Table 7, it can be seen that the seigniorage-maximizing inflation rate
declined over time. More precisely, in phase 1, the seigniorage-maximizing inflation rate
corresponds, as in the Cagan equations of the demand for money, to the ratio 1 , and thus is
equal to 79% per month. By Phase 3, the rate has declined to 1 , that is, to ∝71%. In both
cases, the seigniorage-maximizing inflation rate is less than the ∝actual inflation rate, which
by December 2017 had reached almost 90%. That level of inflation is higher than ṗ ∗
and
ṗ ∗∗, that is, the seigniorage-maximizing and efficient inflation rates, respectively, according
to Cagan (1956) and Bailey (1956).

1
 3 Public Choice (2021) 186:337–350

6 Conclusions

Hyperinflation in Venezuela was politically motivated by redistributional objectives.

Social policies benefited the socialist government’s supporters, who principally were
drawn from the low-income segment of the population. Hyperinflation wiped out real
value of govern- ment bonds held mainly by the middle and upper classes that opposed the
government. The revenue requirements for financing of the social policies suggest a fiscal
origin of hyperin- flation, rather than an origin in the balance of payments. We have
confirmed empirically the fiscal origins of Venezuelan hyperinflation. We also evaluated
the efficiency of the inflation tax. We estimated a demand for money equation with money
substitutable not only for goods, but also for foreign currency or assets, as proposed by
Bernholz (2003). Our empirical results show that the inflation rate was excessive
according to both Cagan’s revenue-maximizing and Bailey’s efficiency criteria.
Inefficiency arose through the govern- ment being on the wrong side of the Laffer curve
for the inflation tax.
Can hyperinflation similar to that of Venezuela be avoided? Bernholz (1987, p. 103)
proposed a monetary constitution that “prevents government and central bankers from
influencing the stock of money”. If such a constitution had been in place in Venezuela,
we do not know whether the constitutional constraints would have been effective, given
the ideology of the socialist government. Bernholz (2017) has studied ideology with ref-
erence to supreme values. A supreme-value objective is sought without regard for other
consequences. The destruction of the market-based Venezuelan economy and acceptance
of hyperinflation for achievement of the ideological supreme-value objectives of socialism
appears to be a case that can be added to the list of supreme-value public policies
complied by Bernholz.

Acknowledgements We thank anonymous referees, Arye Hillman, and participants at the 28th
Silvaplana workshop on political economy for their helpful comments.

References
Abel, A., Dornbusch, R., Huizinga, J., & Marcus, A. (1979). Money demand during hyperinflation. Journal
of Monetary Economics, 5, 97–104.
Bai, J., & Perron, P. (1998). Estimating and testing linear models with multiple structural changes. Econo-
metrica, 66, 47–78.
Bailey, M. J. (1956). The welfare cost of inflationary finance. Journal of Political Economy, 64, 93–110.
Bernholz, P. (1982). Flexible exchange rates in historical perspective. Princeton Studies in International
Finance 49. International Finance Section, Department of Economics, Princeton University NJ.
Bernholz, P. (1988). Hyperinflation and currency reform in Bolivia: Studied from a general perspective.
Journal of Institutional and Theoretical Economics, 144, 747–771.
Bernholz, P. (1987). The implementation and maintainance of a monetary constitution, In J. Dorn, & A. J.
Scwartz (Eds.), The search for stable money. University of Chicago Press: Chicago.
Bernholz, P. (1989). Currency competition, inflation, Gresham’s law and exchange rate. Journal of Institu-
tional and Theoretical Economics, 145, 465–488.
Bernholz, P. (2003). Monetary regimes and inflation: history, economics and political relationship. North-
ampton: Edward Elgar.
Bernholz, P. (2015). Monetary regimes and inflation: History, economic and political relationships (2nd
ed.). Cheltenham: Edward Elgar Publishing.
Bernholz, P. (2017). Totalitarianism, terrorism and supreme values: History and theory. Heidelberg:
Springer.
Brennan, H. G., & Buchanan, J. M. (1980). The power to tax. Indianapolis: Liberty Fund.
Brennan, H. G., & Buchanan, J. M. (1981). Monopoly in money and inflation. London: The Institute of
Economic Affairs.

1
 Public Choice (2021) 186:337–350 3
Cagan, P. (1956). The monetary dynamics of hyperinflation. In M. Friedman (Ed.), Studies in the quantity
theory of money (pp. 25–117). Chicago: University of Chicago Press.
Calvo G. (2012). The price theory of money, Prospero’s liquidity trap and sudden stop. Columbia
University. Corrales, J., & Penfold, M. (2011). Dragon in the tropics: Hugo Chavez and the political
economy of revo-
lution in Venezuela. Washington D.C.: Brookings Institution Press.
Dornbusch, R., & Edwards, S. (1991). The macroeconomics of populism in Latin America. Chicago: The
University of Chicago Press.
Dornbusch, R., Sturzenegger, F., & Wolf, H. (1990). Extreme inflation: Dynamics and stabilization. Brook-
ing Papers on Economic Activity, 2, 1–64.
Fischer, S., Sahay, R., & Vegh, C. A. (2002). Modern hyper- and high inflations. Journal of Economic Lit-
erature, 50, 837–880.
Hillman, A. L. (2019). Public finance and public policy: A political economy perspective on
responsibilities and limitations of government (3rd ed.). Cambridge: Cambridge University Press.
Kiguel, M. A., & Liviatan, N. (1988). Inflationary rigidities and orthodox stabilization policies: Lessons
from Latin America. World Bank Economic Review, 2, 273–298.
Krugman, P. (1979). A model of balance of payments crises. Journal of Money, Credit and Banking, 11,
311–325.
Kulesza, M. (2017). Inflation and hyperinflation in Venezuela (1970s–2016)—a post-Keynesian interpreta-
tion. Working paper no. 93, Institute for International Political Economy, Berlin.
Leon, G. (2014). Strategic redistribution: the political economy of populism in Latin America. European
Journal of Political Economy, 34, 39–51.
Leviathan, N., & Piterman, S. (1986). Accelerating inflation and balance of payment crisis, 1973–1984. In
J. Ben-Porath (Ed.), The Israeli Economy (pp. 320–346). Cambridge: Harvard University Press.
McGuirk, E. F. (2013). The illusory leader: natural resources, taxation and accountability. Public Choice,
154, 285–313.
Montiel, P. J. (1989). Empirical analysis of high-inflation episodes in Argentina, Brazil and Israel. IMF
Staff Papers, 36, 527–549.
Obstfeld, M. (1986). Rational and self-fulfilling balance of payment crisis. American Economic Review, 76,
72–81.
Paldam, M. (1987). Inflation and political instability in eight Latin American countries, 1946–83. Public
Choice, 52, 143–168.
Paldam, M. (1994). The political economy of stopping high inflation. European Journal of Political Econ-
omy, 10, 135–168.
Phylaktis, K., & Taylor, M. (1993), Money demand, the Cagan model and the inflation tax: some Latin
American evidence. Review of Economics and Statistics, 75, 32–37.
Pittaluga, G. B., & Seghezza, E. (2018). Resource rents and populism in resource-dependent economies.
European Journal of Political Economy, 54, 83–88.
Reinhart, C. N. & Santos, M. A. (2015). From financial repression to external distress. NBER, working
paper number 21333, Cambridge MA.
Restuccia, D. (2018). The monetary and fiscal history of Venezuela, 1960–2016. University of Chicago,
Becker Friedman Institute for Economics, Working Paper, number 2018/59. Chicago IL.
Sargent, T., & Wallace, N. (1973). Rational expectations and the dynamics of hyperinflation. International
Economic Review, 14, 328–350.
Sargent, T., & Wallace, N. (1981). Some unpleasant monetarist arithmetic. Federal Reserve Bank of Min-
neapolis Quarterly Review, 5(Fall), 1–17.
Siklos, P. (Ed.). (1995). Great inflations of the 20th century: Theories, policies and evidence. Cheltenham:
Edward Elgar.
Taylor, M. P. (1991). The hyperinflation model of money demand revisited. Journal of Money, Credit and
Banking, 23, 327–351.
Vera, L. (2015). Venezuela 1999–2014: Macro-policy, oil governance and economic performance. Com-
parative Economic Studies, 57, 539–568.

Publisher’s Note Springer Nature remains neutral with regard to jurisdictional claims in published maps and
institutional affiliations.