Description
It starts off with the difference between inflation and hyperinflation.It also talks about how the inflation is measured.It then describes for the reason of hyperinflation in Zimbabwe and also the possible approaches of hyperinflation.It finally wraps off with the current situation in the contry.
ASSIGNMENT ON
Hyperinflation in Zimbabwe
Contents
Contents.....................................................................................................................2 1. Inflation and Hyperinflation:...................................................................................3 1.1 How is Inflation Measured?................................................................................3 1.2 Hyperinflation....................................................................................................3 1.2.1 Common Factors which have caused Hyperinflation in the past.................3 1.3 Difference between Inflation and Hyperinflation...............................................3 2. Hyperinflationary Models........................................................................................4 3. Reasons of Hyperinflation in Zimbabwe.................................................................4 3.1 Timeline of Events.............................................................................................5 3.2 Application of Theoretical Models......................................................................6 4. Possible Approaches to Hyperinflation...................................................................7 4.1 Dollarization:.....................................................................................................7 4.2 Free banking system.........................................................................................8 4.3 Currency board..................................................................................................8 4.4 Financial liberalization.......................................................................................8 5. Current situation.....................................................................................................9
1. Inflation and Hyperinflation:
Inflation is defined as a continuing and rapid rise in the price level. According to Milton Friedman, it is “always and everywhere a monetary phenomenon”. Most economists whether monetarists or Keynesians, agree that proposition.
1.1 How is Inflation Measured?
Inflation is measured as the percentage rate of change of a price index over a particular period of time, normally a year. Therefore, if inflation for a particular week is say 7%, it means the index is 7% higher, than it was in the same week during the previous year. The two most important price indices in India are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). The WPI is India’s most watched cost monitor. Most developed countries use the CPI as an index over the WPI.
1.2 Hyperinflation
Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless. A working definition is that a country is in hyperinflation when its annual inflation rate reaches 1000% p.a. 1.2.1 Common Factors which have caused Hyperinflation in the past ‡ Hyperinflation often occurs when there is a large increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked this causes prices to increase, as the currency loses its value. ‡ Hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath. Because of this, sellers demand a risk premium to accept the currency, and they do this by raising their prices.
One of the most famous examples of hyperinflation occurred in Germany between January 1922 and November 1923. By some estimates, the average price level increased by a factor of 20 billion, doubling every 28 hours.
1.3 Difference between Inflation and Hyperinflation
Inflation refers to any sustained increase in the “cost of living” expenditures. It is usually thought in the terms of Consumer Price Index (or CPI). And, hyperinflation refers to an “out of control” increase of prices, resulting in diminishing value of a country’s currency. This occurs when there is an increase in the money supply in the domestic market which fails to satisfy the very reasons it seeks to combat. Another difference is that while inflation works towards securing the economic stability of a country, hyperinflation seeks to demobilize the same economy further into the web of debts. In Zimbabwe, the economy was in such a condition that the prices of even the basic items are not less than few million dollars. For example, the price of three eggs was 100 billion dollars and the price of a dozen tomatoes
varied between 3-5 million dollars. This shows that during hyperinflation, there are irrational increases in prices which not at all help in any sense, thereby, failing the government to achieve its targets. In other words, hyperinflation is generally associated with paper money as it can easily used to increase the money supply. It effectively destroys the purchasing power of the private and public savings, distorts the economy in favor of extreme consumption, and hoarding of real assets, causing the monetary base (hard currency), to escape the country, while making the afflicted area anathema to investment. Hyperinflation can be triggered as a result of the following conditions: 1. The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain the purchasing power. 2. The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that foreign currency. 3. Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short. 4. Interest rates, wages and prices are linked to a price index and the cumulative inflation rate over three years approaches, or exceeds, 100%.
2. Hyperinflationary Models
1) Confidence Model: Some events or series of event cause the people to lose confidence on the money issuing authority. Because of this, people prefer either keeping goods or money of some other nation. The suppliers start charging premium for their products which is much higher than the actual price. To overcome this, the best policy is changing the backing of the currency by issuing a new currency. 2) Monetary Model: The money issuing bodies start printing money to pay the debts or to cover costs coming up because of social unrest or war. When businesspeople perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency's value. The money issuing authority must then accelerate its expansion to cover these prices, which push the currency value down.
3. Reasons of Hyperinflation in Zimbabwe
At Independence in 1980, the Zimbabwe dollar was worth about USD 1.25. Since then, rampant inflation and the collapse of the economy have severely devalued the currency, causing many organisations to favour using the US dollar or South African rand instead. Inflation was stable until Robert Mugabe began a program of land reforms that primarily focused on taking land from white farmers and redistributing those properties and assets to black farmers; this in turn sent food production and revenues from export of food plummeting. Though inflation in Zimbabwe was a monetary phenomena (the result of Mugabe's government printing money) as can
be seen by the appearance of ever higher face value printed notes (whose face value exceeded the sum of all previously existing notes).
3.1 Timeline of Events
- Early in the 21st century Zimbabwe started to experience chronic inflation. Inflation reached 624% in 2004, then fell back to low triple digits before surging to a new high of 1,730% in 2006. During that time, the Reserve Bank of Zimbabwe revalued its currency on 1 August 2006 at a rate of 1,000 old Zimbabwean dollars to 1 revalued Zimbabwean dollar. - In June 2007 inflation in Zimbabwe had risen to 11,000% year-to-year from an earlier estimate of 9,000%. - On 5 May 2008 the Reserve Bank of Zimbabwe issued bank notes or "bearer cheques" for the value of ZWD 100 million and ZWD 250 million. Ten days later on 15 May, new bearer cheques with a value of ZWD 500 million (then equivalent to about USD 2.5) were issued. Five days later on 20 May a new series of notes in the form of "agro cheques" were issued in denominations of ZWD 5 billion, ZWD 25 billion and ZWD 50 billion. An additional agro cheque was issued for ZWD 100 billion on 21 July. Meanwhile inflation has officially surged to 2,200,000% with some analysts estimating figures surpassing 9,000,000 percent. - As of 22 July 2008 the value of the ZWD had fallen to approximately 688 billion per 1 USD, or 688 trillion pre-August 2006 Zimbabwean dollars. - On 1 August 2008, the Zimbabwe dollar was redenominated by removing 10 zeroes. ZWD 10 billion became 1 dollar after the redenomination. - On 19 August 2008, official figures announced for June estimated the inflation over 11,250,000 percent. Zimbabwe's annual inflation was 231,000,000% in Jul. (prices doubling every 17.3 days). - For periods after July 2008, no official inflation statistics were released. Prof. Steve H. Hanke overcame the problem by estimating inflation rates after July 2008 and publishing the Hanke Hyperinflation Index for Zimbabwe. Prof. Hanke’s HHIZ measure indicates that the inflation peaked at an annual rate of 89.7 sextillion percent (89,700,000,000,000,000,000,000%) in mid-November 2008. The peak monthly rate was 79.6 billion percent, which is equivalent to a 98% daily rate. At that rate, prices were doubling every 24.7 hours. - At its November 2008 peak, Zimbabwe’s rate of inflation approached, but failed to surpass, Hungary’s July 1946 world record. - On 16 January 2009, Zimbabwe issued a ZWD100 trillion bill. The hyperinflation officially ended in January 2009 when official inflation rates in USD were announced.
- In February the government of Zimbabwe revalued its currency. One of these new Zimbabwean dollars is worth one trillion of the previous. This move took the number of decimal places removed during the period of hyperinflation to 25 (1025 = 10 septillion short scale; thus, if no revaluations had taken place, Zimbabwe would now be issuing 10 septillion dollar notes).
3.2 Application of Theoretical Models
According to “Quantity theory of money”, Massive imbalance between the supply and demand of a certain currency or type of money, usually due to a complete loss of confidence in the currency similar to a bank-run causes hyperinflation. This situation occurred in Zimbabwe because of the following reasons: 1. The unbudgeted government expenditure of 1997 (to pay the war veterans gratuities) 2. The publicly condemned and unjustifiable Zimbabwe’s intervention in the Democratic Republic of Congo (DRC)’s war in 1998 3. The expenses of the controversial land reform (beginning 2000) 4. The parliamentary (2000/2005) and presidential (2002) elections 5. Introduction of senators in 2005 (at least 66 posts) as part of ‘widening the think tank base’ -the international payments obligations 6. Especially since 2004, all resulted in massive money printing by the government. IMF has said however that the principal causes of inflation, chiefly reckless state spending, arbitrary government controls and the flight of foreign investment remain unchanged, and warns that little change can be expected until issues of political governance are deal with. According to Cost-Push Theory of Inflation, Prices rise due to increasing cost of the factors of production. Given the acute shortage of foreign currency in the country since 2000 (due to, and not limited to, exports decline, closed donor community, dried foreign currency reserves and reduced financial aid from IMF and World Bank), most imports have been financed by expensive foreign currency from the black market, thus resulting in higher output costs surfacing in higher market/consumer prices. Presently termed "supply shock inflation," it is caused by drops in aggregate supply due to increased prices of inputs, for example. Unavailability of forex being a key driver of cost push inflation in Zimbabwe. According to Demand-Pull Theory, Inflationary pressures arise because of excess demand for goods and services resulting from expansionary monetary and fiscal policies. Zimbabwean situation has been compounded by shortages of basic commodities (i.e., mealie-meal (staple diet), cooking oil, flour, fuel, sugar, to mention a few), thus result in pent-up upward pressure in the overall prices. Inflation and Expectations: Both households and firms form their expectations of inflation based on recently observed inflation and this may affect the general price level. Proponents of the theory maintain that prices are rising because people expect them to rise and they expect them to rise because they have seen them rising.
Structural Factors: The effects of droughts since 2000 coupled with under utilization of most commercial farms (after the land reform) have also resulted in production decline and shortages of most locally produced consumption products. Other factors: Foreign currency shortages as well as exchange rate misalignment have also resulted in general increase in prices. Added to the shortage is the exchange rate misalignment where by the official exchange has been far below the market-determined rates, resulting in a growing black/parallel market for foreign currency. Due to this shortage, imports of raw materials have been acquired using expensive foreign currency from the black market. The ultimate effect of this has been cost-push inflation.
4. Possible Approaches to Hyperinflation
The quickest way to stop hyperinflation in Zimbabwe is to replace central banking with a new monetary regime. This would instill confidence in the currency. In Zimbabwe’s historical experience with a variety of monetary systems, only central banking has produced hyperinflation. Similarly, throughout the world, hyperinflation has been a phenomenon linked to central banking or its close cousin, the direct issue of currency by a government’s treasury. During the transition, real interest rates have often been punishingly high, and longterm loans in local currency have been difficult to obtain. As a result, economic growth has been relatively slow, general living standards have remained stagnant, and the scourge of poverty has spread. For replacing the central bank with some other monetary regime Zimbabwe has 3 options available 1) Dollarization 2) Currency board 3) Free banking These options are not mutually exclusive. For example, a currency board system could be combined with official dollarization, as in the monetary systems of Lesotho, Namibia, and Swaziland. 4.1 Dollarization: 1. Unofficial When individual holds foreign currency, bank deposits or notes to protect against the inflation in domestic currency. Zimbabwe was already unofficially dollarized to the extent that Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. Zimbabwe is already unofficially dollarized to the extent that Zimbabweans
hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. 2. Semi-official Under semiofficial dollarization, foreign currency is legal tender and may even dominate bank deposits, but it plays a secondary role to domestic currency in paying wages, taxes, and everyday expenses such as grocery and electric bills. Unlike officially dollarized countries, semiofficially dollarized ones retain a domestic central bank or other monetary authority and have corresponding latitude to conduct their own monetary policy. 3. Official
Official dollarization could be based on, for example, the South African rand, the U.S. dollar, or the euro. If Zimbabwe used the rand, it could negotiate a profit-sharing agreement such as Lesotho and Namibia now have, and which Botswana and Swaziland formerly had. Under these agreements, South Africa shares the profit (seigniorage) it derives from issuing currency, according to estimates of how many rand notes (paper money) and coins are in circulation in the partner country. 4.2 Free banking system A completely free banking system has no central bank, no lender of last resort, no reserve requirements, and no legal restrictions on bank portfolios, interest rates, or branch banking. Free banking systems existed in nearly 60 countries during the 1800s and early 1900s. In general, these systems were relatively stable, issued currencies convertible into gold or silver at fixed exchange rates, and were not purveyors of inflation. Zimbabwe had free banking from the time its first bank was established in 1892 but it was replaced by currency board in 1940. 4.3 Currency board Zimbabwe had currency board in 1940. A currency board is a monetary institution that issues notes and coins. A currency board’s monetary liabilities are fully backed by a foreign reserve currency (also called the anchor currency) and are freely convertible into the reserve currency at a fixed rate on demand. The reserve currency is a convertible foreign currency or a commodity chosen for its expected stability. a currency board holds low-risk, interest-earning securities and other assets payable in the reserve currency. A currency board holds reserves equal to 100 percent or slightly more of its notes and coins in circulation, as set by law. 4.4 Financial liberalization With the elimination of hyperinflation, the rationale for price controls and foreign exchange controls no longer exists. Both should be prohibited. Other forms of “financial repression,” including interest rate ceilings, the forced purchase of government bonds, minimum reserve requirements for financial institutions, and the compulsory allocation of credit to favored borrowers should also be prohibited. This liberalization would permit the free flow of capital into and out of Zimbabwe. It would also increase the return on savings and reduce the cost of capital in
Zimbabwe, removing major impediments to economic growth and improved living standards.
5. Current situation
In January 2009, Zimbabwe government abandoned the Zimbabwe dollar and allowed trading in US dollars or other foreign currencies. Since February 2, 2009 Zimbabwe has adopted hard currencies for transactions. On March 19, 2009, the South African rand was announced as the reference currency. Zimbabwe dollardenominated currency is not functional, and there is no functioning foreign exchange market for Zimbabwe dollars. In April 2009, Zimbabwe abandoned printing of the Zimbabwean dollar, and the South African rand and US dollar became the standard currencies for exchange. The de facto exchange arrangement is classified as other managed exchange arrangement. And the government does not intend to reintroduce the currency until 2010. Due to this the inflation came to down drastically and is now reached the level of deflation. The month-on-month inflation rate in May was -1%, compared with -1.1% in April. Food prices declined more slowly in May, with the month-on-month rate for food and non-alcoholic beverages inflation at -0.84%, compared with -2.91% in April. Since trading in foreign currency was allowed, Zimbabwe's once-deserted shops are again fully stocked with food. But even with prices falling, few people can afford to buy food in a country where the unemployment rate is estimated at 94%.Early this month, the United Nations Development Programme appealed for $718-million, which includes food aid for about half the population. The unity government formed in February between long-ruling President Robert Mugabe and his one-time rival, Prime Minister Morgan Tsvangirai, is trying to convince donors to give $8.5-billion to revive the economy and the civil service. Norway announced an increase in aid to about $31-million, while Germany has promised nearly $28-million through the World Bank. – AFP. US and other Western countries say they are still concerned that Mugabe has not made enough political reforms.
doc_611740926.doc
It starts off with the difference between inflation and hyperinflation.It also talks about how the inflation is measured.It then describes for the reason of hyperinflation in Zimbabwe and also the possible approaches of hyperinflation.It finally wraps off with the current situation in the contry.
ASSIGNMENT ON
Hyperinflation in Zimbabwe
Contents
Contents.....................................................................................................................2 1. Inflation and Hyperinflation:...................................................................................3 1.1 How is Inflation Measured?................................................................................3 1.2 Hyperinflation....................................................................................................3 1.2.1 Common Factors which have caused Hyperinflation in the past.................3 1.3 Difference between Inflation and Hyperinflation...............................................3 2. Hyperinflationary Models........................................................................................4 3. Reasons of Hyperinflation in Zimbabwe.................................................................4 3.1 Timeline of Events.............................................................................................5 3.2 Application of Theoretical Models......................................................................6 4. Possible Approaches to Hyperinflation...................................................................7 4.1 Dollarization:.....................................................................................................7 4.2 Free banking system.........................................................................................8 4.3 Currency board..................................................................................................8 4.4 Financial liberalization.......................................................................................8 5. Current situation.....................................................................................................9
1. Inflation and Hyperinflation:
Inflation is defined as a continuing and rapid rise in the price level. According to Milton Friedman, it is “always and everywhere a monetary phenomenon”. Most economists whether monetarists or Keynesians, agree that proposition.
1.1 How is Inflation Measured?
Inflation is measured as the percentage rate of change of a price index over a particular period of time, normally a year. Therefore, if inflation for a particular week is say 7%, it means the index is 7% higher, than it was in the same week during the previous year. The two most important price indices in India are the Consumer Price Index (CPI) and the Wholesale Price Index (WPI). The WPI is India’s most watched cost monitor. Most developed countries use the CPI as an index over the WPI.
1.2 Hyperinflation
Hyperinflation is a situation where the price increases are so out of control that the concept of inflation is meaningless. A working definition is that a country is in hyperinflation when its annual inflation rate reaches 1000% p.a. 1.2.1 Common Factors which have caused Hyperinflation in the past ‡ Hyperinflation often occurs when there is a large increase in the money supply not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and demand for the money. Left unchecked this causes prices to increase, as the currency loses its value. ‡ Hyperinflation often occurs when there is a loss of confidence in a currency's ability to maintain its value in the aftermath. Because of this, sellers demand a risk premium to accept the currency, and they do this by raising their prices.
One of the most famous examples of hyperinflation occurred in Germany between January 1922 and November 1923. By some estimates, the average price level increased by a factor of 20 billion, doubling every 28 hours.
1.3 Difference between Inflation and Hyperinflation
Inflation refers to any sustained increase in the “cost of living” expenditures. It is usually thought in the terms of Consumer Price Index (or CPI). And, hyperinflation refers to an “out of control” increase of prices, resulting in diminishing value of a country’s currency. This occurs when there is an increase in the money supply in the domestic market which fails to satisfy the very reasons it seeks to combat. Another difference is that while inflation works towards securing the economic stability of a country, hyperinflation seeks to demobilize the same economy further into the web of debts. In Zimbabwe, the economy was in such a condition that the prices of even the basic items are not less than few million dollars. For example, the price of three eggs was 100 billion dollars and the price of a dozen tomatoes
varied between 3-5 million dollars. This shows that during hyperinflation, there are irrational increases in prices which not at all help in any sense, thereby, failing the government to achieve its targets. In other words, hyperinflation is generally associated with paper money as it can easily used to increase the money supply. It effectively destroys the purchasing power of the private and public savings, distorts the economy in favor of extreme consumption, and hoarding of real assets, causing the monetary base (hard currency), to escape the country, while making the afflicted area anathema to investment. Hyperinflation can be triggered as a result of the following conditions: 1. The general population prefers to keep its wealth in non-monetary assets or in a relatively stable foreign currency. Amounts of local currency held are immediately invested to maintain the purchasing power. 2. The general population regards monetary amounts not in terms of the local currency but in terms of a relatively stable foreign currency. Prices may be quoted in that foreign currency. 3. Sales and purchases on credit take place at prices that compensate for the expected loss of purchasing power during the credit period, even if the period is short. 4. Interest rates, wages and prices are linked to a price index and the cumulative inflation rate over three years approaches, or exceeds, 100%.
2. Hyperinflationary Models
1) Confidence Model: Some events or series of event cause the people to lose confidence on the money issuing authority. Because of this, people prefer either keeping goods or money of some other nation. The suppliers start charging premium for their products which is much higher than the actual price. To overcome this, the best policy is changing the backing of the currency by issuing a new currency. 2) Monetary Model: The money issuing bodies start printing money to pay the debts or to cover costs coming up because of social unrest or war. When businesspeople perceive that the issuer is committed to a policy of rapid currency expansion, they mark up prices to cover the expected decay in the currency's value. The money issuing authority must then accelerate its expansion to cover these prices, which push the currency value down.
3. Reasons of Hyperinflation in Zimbabwe
At Independence in 1980, the Zimbabwe dollar was worth about USD 1.25. Since then, rampant inflation and the collapse of the economy have severely devalued the currency, causing many organisations to favour using the US dollar or South African rand instead. Inflation was stable until Robert Mugabe began a program of land reforms that primarily focused on taking land from white farmers and redistributing those properties and assets to black farmers; this in turn sent food production and revenues from export of food plummeting. Though inflation in Zimbabwe was a monetary phenomena (the result of Mugabe's government printing money) as can
be seen by the appearance of ever higher face value printed notes (whose face value exceeded the sum of all previously existing notes).
3.1 Timeline of Events
- Early in the 21st century Zimbabwe started to experience chronic inflation. Inflation reached 624% in 2004, then fell back to low triple digits before surging to a new high of 1,730% in 2006. During that time, the Reserve Bank of Zimbabwe revalued its currency on 1 August 2006 at a rate of 1,000 old Zimbabwean dollars to 1 revalued Zimbabwean dollar. - In June 2007 inflation in Zimbabwe had risen to 11,000% year-to-year from an earlier estimate of 9,000%. - On 5 May 2008 the Reserve Bank of Zimbabwe issued bank notes or "bearer cheques" for the value of ZWD 100 million and ZWD 250 million. Ten days later on 15 May, new bearer cheques with a value of ZWD 500 million (then equivalent to about USD 2.5) were issued. Five days later on 20 May a new series of notes in the form of "agro cheques" were issued in denominations of ZWD 5 billion, ZWD 25 billion and ZWD 50 billion. An additional agro cheque was issued for ZWD 100 billion on 21 July. Meanwhile inflation has officially surged to 2,200,000% with some analysts estimating figures surpassing 9,000,000 percent. - As of 22 July 2008 the value of the ZWD had fallen to approximately 688 billion per 1 USD, or 688 trillion pre-August 2006 Zimbabwean dollars. - On 1 August 2008, the Zimbabwe dollar was redenominated by removing 10 zeroes. ZWD 10 billion became 1 dollar after the redenomination. - On 19 August 2008, official figures announced for June estimated the inflation over 11,250,000 percent. Zimbabwe's annual inflation was 231,000,000% in Jul. (prices doubling every 17.3 days). - For periods after July 2008, no official inflation statistics were released. Prof. Steve H. Hanke overcame the problem by estimating inflation rates after July 2008 and publishing the Hanke Hyperinflation Index for Zimbabwe. Prof. Hanke’s HHIZ measure indicates that the inflation peaked at an annual rate of 89.7 sextillion percent (89,700,000,000,000,000,000,000%) in mid-November 2008. The peak monthly rate was 79.6 billion percent, which is equivalent to a 98% daily rate. At that rate, prices were doubling every 24.7 hours. - At its November 2008 peak, Zimbabwe’s rate of inflation approached, but failed to surpass, Hungary’s July 1946 world record. - On 16 January 2009, Zimbabwe issued a ZWD100 trillion bill. The hyperinflation officially ended in January 2009 when official inflation rates in USD were announced.
- In February the government of Zimbabwe revalued its currency. One of these new Zimbabwean dollars is worth one trillion of the previous. This move took the number of decimal places removed during the period of hyperinflation to 25 (1025 = 10 septillion short scale; thus, if no revaluations had taken place, Zimbabwe would now be issuing 10 septillion dollar notes).
3.2 Application of Theoretical Models
According to “Quantity theory of money”, Massive imbalance between the supply and demand of a certain currency or type of money, usually due to a complete loss of confidence in the currency similar to a bank-run causes hyperinflation. This situation occurred in Zimbabwe because of the following reasons: 1. The unbudgeted government expenditure of 1997 (to pay the war veterans gratuities) 2. The publicly condemned and unjustifiable Zimbabwe’s intervention in the Democratic Republic of Congo (DRC)’s war in 1998 3. The expenses of the controversial land reform (beginning 2000) 4. The parliamentary (2000/2005) and presidential (2002) elections 5. Introduction of senators in 2005 (at least 66 posts) as part of ‘widening the think tank base’ -the international payments obligations 6. Especially since 2004, all resulted in massive money printing by the government. IMF has said however that the principal causes of inflation, chiefly reckless state spending, arbitrary government controls and the flight of foreign investment remain unchanged, and warns that little change can be expected until issues of political governance are deal with. According to Cost-Push Theory of Inflation, Prices rise due to increasing cost of the factors of production. Given the acute shortage of foreign currency in the country since 2000 (due to, and not limited to, exports decline, closed donor community, dried foreign currency reserves and reduced financial aid from IMF and World Bank), most imports have been financed by expensive foreign currency from the black market, thus resulting in higher output costs surfacing in higher market/consumer prices. Presently termed "supply shock inflation," it is caused by drops in aggregate supply due to increased prices of inputs, for example. Unavailability of forex being a key driver of cost push inflation in Zimbabwe. According to Demand-Pull Theory, Inflationary pressures arise because of excess demand for goods and services resulting from expansionary monetary and fiscal policies. Zimbabwean situation has been compounded by shortages of basic commodities (i.e., mealie-meal (staple diet), cooking oil, flour, fuel, sugar, to mention a few), thus result in pent-up upward pressure in the overall prices. Inflation and Expectations: Both households and firms form their expectations of inflation based on recently observed inflation and this may affect the general price level. Proponents of the theory maintain that prices are rising because people expect them to rise and they expect them to rise because they have seen them rising.
Structural Factors: The effects of droughts since 2000 coupled with under utilization of most commercial farms (after the land reform) have also resulted in production decline and shortages of most locally produced consumption products. Other factors: Foreign currency shortages as well as exchange rate misalignment have also resulted in general increase in prices. Added to the shortage is the exchange rate misalignment where by the official exchange has been far below the market-determined rates, resulting in a growing black/parallel market for foreign currency. Due to this shortage, imports of raw materials have been acquired using expensive foreign currency from the black market. The ultimate effect of this has been cost-push inflation.
4. Possible Approaches to Hyperinflation
The quickest way to stop hyperinflation in Zimbabwe is to replace central banking with a new monetary regime. This would instill confidence in the currency. In Zimbabwe’s historical experience with a variety of monetary systems, only central banking has produced hyperinflation. Similarly, throughout the world, hyperinflation has been a phenomenon linked to central banking or its close cousin, the direct issue of currency by a government’s treasury. During the transition, real interest rates have often been punishingly high, and longterm loans in local currency have been difficult to obtain. As a result, economic growth has been relatively slow, general living standards have remained stagnant, and the scourge of poverty has spread. For replacing the central bank with some other monetary regime Zimbabwe has 3 options available 1) Dollarization 2) Currency board 3) Free banking These options are not mutually exclusive. For example, a currency board system could be combined with official dollarization, as in the monetary systems of Lesotho, Namibia, and Swaziland. 4.1 Dollarization: 1. Unofficial When individual holds foreign currency, bank deposits or notes to protect against the inflation in domestic currency. Zimbabwe was already unofficially dollarized to the extent that Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. Zimbabwe is already unofficially dollarized to the extent that Zimbabweans
hold South African rand, U.S. dollars, pounds sterling, and other foreign currencies as stores of value. 2. Semi-official Under semiofficial dollarization, foreign currency is legal tender and may even dominate bank deposits, but it plays a secondary role to domestic currency in paying wages, taxes, and everyday expenses such as grocery and electric bills. Unlike officially dollarized countries, semiofficially dollarized ones retain a domestic central bank or other monetary authority and have corresponding latitude to conduct their own monetary policy. 3. Official
Official dollarization could be based on, for example, the South African rand, the U.S. dollar, or the euro. If Zimbabwe used the rand, it could negotiate a profit-sharing agreement such as Lesotho and Namibia now have, and which Botswana and Swaziland formerly had. Under these agreements, South Africa shares the profit (seigniorage) it derives from issuing currency, according to estimates of how many rand notes (paper money) and coins are in circulation in the partner country. 4.2 Free banking system A completely free banking system has no central bank, no lender of last resort, no reserve requirements, and no legal restrictions on bank portfolios, interest rates, or branch banking. Free banking systems existed in nearly 60 countries during the 1800s and early 1900s. In general, these systems were relatively stable, issued currencies convertible into gold or silver at fixed exchange rates, and were not purveyors of inflation. Zimbabwe had free banking from the time its first bank was established in 1892 but it was replaced by currency board in 1940. 4.3 Currency board Zimbabwe had currency board in 1940. A currency board is a monetary institution that issues notes and coins. A currency board’s monetary liabilities are fully backed by a foreign reserve currency (also called the anchor currency) and are freely convertible into the reserve currency at a fixed rate on demand. The reserve currency is a convertible foreign currency or a commodity chosen for its expected stability. a currency board holds low-risk, interest-earning securities and other assets payable in the reserve currency. A currency board holds reserves equal to 100 percent or slightly more of its notes and coins in circulation, as set by law. 4.4 Financial liberalization With the elimination of hyperinflation, the rationale for price controls and foreign exchange controls no longer exists. Both should be prohibited. Other forms of “financial repression,” including interest rate ceilings, the forced purchase of government bonds, minimum reserve requirements for financial institutions, and the compulsory allocation of credit to favored borrowers should also be prohibited. This liberalization would permit the free flow of capital into and out of Zimbabwe. It would also increase the return on savings and reduce the cost of capital in
Zimbabwe, removing major impediments to economic growth and improved living standards.
5. Current situation
In January 2009, Zimbabwe government abandoned the Zimbabwe dollar and allowed trading in US dollars or other foreign currencies. Since February 2, 2009 Zimbabwe has adopted hard currencies for transactions. On March 19, 2009, the South African rand was announced as the reference currency. Zimbabwe dollardenominated currency is not functional, and there is no functioning foreign exchange market for Zimbabwe dollars. In April 2009, Zimbabwe abandoned printing of the Zimbabwean dollar, and the South African rand and US dollar became the standard currencies for exchange. The de facto exchange arrangement is classified as other managed exchange arrangement. And the government does not intend to reintroduce the currency until 2010. Due to this the inflation came to down drastically and is now reached the level of deflation. The month-on-month inflation rate in May was -1%, compared with -1.1% in April. Food prices declined more slowly in May, with the month-on-month rate for food and non-alcoholic beverages inflation at -0.84%, compared with -2.91% in April. Since trading in foreign currency was allowed, Zimbabwe's once-deserted shops are again fully stocked with food. But even with prices falling, few people can afford to buy food in a country where the unemployment rate is estimated at 94%.Early this month, the United Nations Development Programme appealed for $718-million, which includes food aid for about half the population. The unity government formed in February between long-ruling President Robert Mugabe and his one-time rival, Prime Minister Morgan Tsvangirai, is trying to convince donors to give $8.5-billion to revive the economy and the civil service. Norway announced an increase in aid to about $31-million, while Germany has promised nearly $28-million through the World Bank. – AFP. US and other Western countries say they are still concerned that Mugabe has not made enough political reforms.
doc_611740926.doc