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Venezuela: policies to save the economy?

In the UK, petrol prices have fallen significantly over the past couple of years and currently stand in some places at below £1 per litre. For UK residents, this price is seen as being cheap, but if we compare it to prices in Venezuela, we get quite a different picture. Prices are increasing here for the first time in 20 years from $0.01 per litre to $0.60 per litre – around 40 pence, while lower grade petrol increases to $0.10 per litre.

Venezuela has oil fields in abundance, but has not used this natural resource to its full potential to bolster the struggling economy. The price of petrol has been heavily subsidised for decades and the removal of this subsidy is expected to save around $800 million per year.

This will be important for the economy, given its poor economic growth, high inflation and shortages of some basic products. Venezuela relies on oil as the main component of its export revenues and so it has been hit very badly, by such low oil prices. The money from this reduced subsidy will be used to help social programmes across the country, which over time should help the economy.

In addition to this reduced subsidy on petrol prices, Venezuela’s President has also taken steps to devalue the exchange rate. This will help to boost the economy’s competitiveness and so is another policy being implemented to help the economy. However, some analysts have said that these changes don’t go far enough, calling them ‘small steps’, ‘nowhere near what is required’ and ‘late and insufficient’. The following articles consider the Venezuelan crisis and policies.

Venezuela raises petrol price for first time in 20 years BBC News (18/02/16)
Venezuela president raises fuel price by 6,000% and devalues bolivar to tackle crisis The Guardian, Sibylla Brodzinsky (18/02/16)
Venezuela’s Maduro devalues currency and raises gasoline prices Financial Times, Andres Schipani (18/02/16)
Venezuela hikes gasoline price for first time in 20 years The Economic Times (18/02/16)
Venezuela hikes fuel prices by 6000%, devalues currency to tackle economic crisis International Business Times, Avaneesh Pandey (18/02/16)
Market dislikes Venezuela reforms but debt rallies again Reuters (18/02/16)

Questions

  1. Why are oil prices so important for the Venezuelan economy?
  2. How will they affect the country’s export revenues and hence aggregate demand?
  3. Inflation in Venezuela has been very high recently. What is the cause of such high inflation? Illustrate this using an aggregate demand/aggregate supply diagram.
  4. How will a devaluation of the currency help Venezuela? How does this differ from a depreciation?
  5. Petrol prices have been subsidised in Venezuela for 20 years. Show how this government subsidy has affected petrol prices. Now that this subsidy is being reduced, how will this affect prices – show this on your diagram.
  6. Why are many analysts suggesting that these policies are insufficient to help the Venezuelan economy?
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