Monetary policy in Venezuela is not like monetary policy in other countries. The reason, of course, is oil. Because of the constant flow of oil dollars into the economy, the Central Bank must continuously both buy dollars from PDVSA and sell them into the economy to soak up excess bolivars. Under the system of exchange rate bands that was in force until February, it was difficult for the market to distinguish between this kind of operation and identical operations designed to influence the exchange rate.
Now, all that has changed. Since the devaluation in February, the Central Bank has let the exchange rate float as dictated by the market. It sells every day an amount of dollars notified in advance (currently $45 million in three auctions of $15 million). Any variation on that pattern is considered intervention. The bank has on a few occasions sold an extra $10 million dollars and on one occasion sold less than the full $15 million – hardly dramatic in a market that commonly turns over $300 million a day. The bank insists that such actions are designed to correct excessive volatility in the market, not to influence the underlying exchange rate.
Certainly the exchange rate seems to have taken its own route since the devaluation. That’s bad news for inflation. Because Venezuela’s imports are equal to almost half of GDP, the pass-through of devaluation into inflation is substantial. In 2002, prices are expected to rise by about 30%.
How will the Central Bank deal with inflation? For the time being, it won’t. The bank expects that if President Chávez’s new ministers prevail, monetary policy will be based on inflation targeting. But that can’t be done while the fiscal deficit remains out of control – and bringing it under control will take at least two years, even given the necessary political will.In the meantime the bank must do its best within the constraints of the fiscal situation. In sum, that means using interest rates and reserve requirements to keep a squeeze on the monetary base – not the most sophisticated of instruments, but in the current circumstances, they are all the Central Bank has.