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Chapter 25: Problem 9

An article in the Wall Street Journal in 2017 about Venezuela noted, "The economy has shrunk by an estimated \(27 \%\) since \(2013 .\) The International Monetary Fund says inflation this year will hit \(720 \%\)." Are these facts related? Briefly explain.

Short Answer

Expert verified
Yes, the facts are related. The shrinkage in the Venezuelan economy might have led the government to increase the money supply to stimulate spending, which in turn, devalued the currency and led to an increase in inflation to 720% as noted by the IMF.

Step by step solution

01

Understanding Inflation and Economic Shrinkage

Inflation is defined as an overall increase in price level in an economy over a period of time. When inflation rate is high, the value of money decreases. On the other hand, economic shrinkage, or economic contraction, refers to a decrease in a country's gross domestic product (GDP), which is the total value of all goods and services produced by the country. When a country's GDP decrease, it generally signifies a slowing economy.
02

Explanation of the relationship

Inflation and economic shrinkage can indeed be related. When an economy is shrinking, it typically means there is less production and less spending. In response, a government may decide to print more money to stimulate spending. However, when more money is in circulation, it can devalue the currency and cause prices to rise – which is inflation. Therefore, it's possible that a shrinking economy can lead to higher inflation.
03

Application to the Venezuelan context

In the case of Venezuela, the economy has shrunk by an estimated 27% since 2013, which means less production and possibly less spending occurred during this period. Also, inflation has increased to 720% according to the IMF. This might have occurred due to an increase in money supply to combat the shrinking economy. Therefore, the facts of economic shrinkage and inflation are related in Venezuela's case.

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