Peru’s Monetary System Would Not Work in Venezuela
Venezuela’s National Assembly is actively debating how to end the world’s highest inflation rate and retire the bolivar, the world’s worst-performing currency. One of us is advising that debate directly. Naturally, during the past few weeks, the discussion about how to kill Venezuela’s inflation, the world’s highest, and what to do with the bolivar, the world’s worst-performing currency, has heated up.
Some Venezuelans have argued that the most desirable option to solve the bolivar-inflation problem would be to adopt the Peruvian system. While this system has performed well in Peru, it is the product of a unique set of circumstances that are not exportable. It would not work in Venezuela. Indeed, the idea that the adoption of Peru’s system would solve Venezuela’s monetary problems is not only mistaken, but dangerous.
Why do people advocate the Peruvian system? Because it is one of the few Latin American success stories. Following Peru’s hyperinflations of 1988 and 1990 and its economic collapse, Peru introduced a monetary regime in 2002 that has hit or come close to hitting its inflation target of 1%-3% most of the time. Indeed, inflation has only exceeded the upper bound of the target range four times in the 24 years since inflation targeting was introduced, and three of those four years occurred during the COVID pandemic. In addition to relatively low inflation, Peru’s system has delivered a relatively stable currency, resilience to major economic shocks, and sustained economic growth.
To achieve these results, the Peruvian central bank (BCRP) combines interest-rate policy with extensive foreign-exchange intervention, large precautionary reserves, sterilization, countercyclical reserve requirements and macroprudential measures. At times it has also imposed extremely high reserve requirements on certain short-term capital inflows. In addition, perhaps the secret sauce of the system is the fact that it is de facto a dual monetary system. While the sol is Peru’s legal tender, Peruvians have a constitutionally guaranteed right to hold and use U.S. dollars. In addition, the banking system operates with both the sol and the dollar. As a result, currency competition provides an additional source of discipline for the BCRP.
Peru’s system is hardly a textbook example of a freely floating exchange-rate regime combined with inflation targeting. But, it has worked remarkably well.
Importantly, the success of Peru’s system is the result of an unusual combination of local, political and institutional factors that have, for over a quarter of a century, influenced the development of Peru’s system.
The BCRP is exceptionally well managed. Julio Velarde has led the BCRP since 2006. Velarde is highly respected and trusted. As President of the BCRP, he has served for an unusually long period of time and under governments of very different political orientations. Behind him stands a highly professional technical staff with considerable institutional memory.
Peru has also maintained an unusual degree of technocratic continuity and stability at the Ministry of Economy and Finance. As a result, prudent fiscal policy has played an important complementary macroeconomic role in Peru. For example, during good years, the government has accumulated financial buffers, rather than spending the resulting fiscal windfall.
Peru has repeatedly demonstrated the capacity to follow rules. Countries like Venezuela, where populism reigns supreme, have not followed, and cannot follow rules that discipline monetary and fiscal affairs.
The institutional foundations of the Peruvian regime are the product of circumstances that are neither easy to replicate nor necessarily desirable to reproduce.
In the wake of hyperinflation and economic collapse, Alberto Fujimori came to power in Peru in 1990. His initial stabilization program, the Fujishock, involved a severe fiscal and monetary adjustment. But, stabilization was slow to arrive. It took years to build credibility.
The decisive institutional break came after Fujimori’s autogolpe of April 1992, when he dissolved Congress and suspended the existing constitutional order. The 1993 Constitution that followed established the autonomy of the BCRP and imposed important restrictions on the BCRP’s ability to extend credit to the government. The institutional foundations of today’s successful monetary regime were therefore established and cemented during Fujimori’s presidency, which ended in November 2000. But, it wasn’t until 2002 that the current BCRP operational system was put in place.
This history matters. It is easy to look at Peru today and observe an independent, highly professional central bank and recommend that Venezuela simply create something similar. But, such a recommendation ignores the political process through which Peru’s system was created and how it acquired its legitimacy and credibility.
The possibility of cloning the Peruvian system in Venezuela also ignores how long the process took. Peru did not achieve price stability overnight. Annual inflation did not remain below 10% until 1997, almost seven years after Fujimori’s Fujishock. By comparison, Ecuador’s dollarization produced a much more rapid disinflation and stabilization.
Peru’s subsequent political history is equally unusual. Since 2016, no president has completed a full term. As a result, even if a president wanted to reform Peru’s system, they weren’t able to accumulate enough political power to do so. Importantly, radical reform was not merely a hypothetical risk. Pedro Castillo was elected president in 2021. He promised a constituent assembly, a new constitution, and a fundamental overhaul of Peru’s economic model. Castillo only lasted sixteen months, and Peru’s existing monetary and fiscal regime survived intact.
Paradoxically, Peru’s extraordinary political instability has helped reinforce the independence of the BCRP and the continuity of the technical staff at the Treasury. Governments and ministers have come and gone, but Velarde has remained at the head of the BCRP since 2006. Such remarkable institutional continuity is another reason why Peru’s monetary system cannot easily be replicated elsewhere.
Like Argentina, Venezuela has a long history of populism, fiscal dominance, and institutional anomie. Venezuela’s problem has not been a shortage of economists capable of designing sophisticated monetary and fiscal regimes, but its inability to follow strict rules in good times and bad. Peru’s ability to do precisely that is one of the main reasons its system has worked so well.
The Peruvian system has a solid institutional foundation that was legitimized over time and is supported by the Peruvian public. As a result, it is unique and unexportable to other Latin American countries. In short, the Peruvian system cannot be successfully replicated.
So, what should be done to put an end to Venezuela’s inflation plague once and for all? Venezuela should mothball the bolivar, put it in a museum, and adopt the U.S. dollar as its legal tender. Under a dollarized system, there would be no Venezuelan monetary rules to break. The dollarized system would therefore not be subject to political manipulation and rule-breaking.In addition, a dollarized system would deliver much-needed stability, and while stability is not everything, everything is nothing without stability. This would be guaranteed. No “dollarized” system has ever failed. The opinions expressed in Fortune.com commentary pieces are solely the views of their authors and do not necessarily reflect the opinions and beliefs of Fortune.
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