ECONOMY & FINANCE
How Zimbabwe lost control of inflation
The main cause of hyperinflation is a massive and rapid increase in the amount of money (estimated at 17,000%), which is not supported by growth in the output of goods and services.
This results in an imbalance between the supply and demand for the money (including currency and bank deposits), accompanied by a complete loss of confidence in the money, similar to a bank run.
The enactment of legal tender laws and price controls to prevent discounting the value of paper money relative to gold, silver, hard currency, or commodities, fails to force acceptance of paper money which lacks intrinsic value.
When the entity responsible for printing a currency promotes excessive money printing, with other factors contributing a reinforcing effect, hyperinflation usually continues.
The body responsible for printing the currency cannot physically print paper currency faster than the rate at which it is devaluing, thus neutralising their attempts to stimulate the economy. This is clear with the new $750,000 bearer (or is it burial) cheque. The country’s highest note cannot even buy a loaf of bread. Can you imagine walking into Tesco in the UK and one loaf costing more than £50, or being in Walmart in the USA, and a loaf going for more than US$100? Imagine being in No Frills, in Canada one loaf going for more than C$100? This is how Zimbabwe’s currency has been absurdly decimated by inflation.
Zimbabwe’s hyper-Inflation is a result of the monetary authority irresponsibly borrowing money to pay all its expenses and funding quasi-fiscal activities (which are normally left to Central Government). In Neoliberalism, hyperinflation is considered to be the result of a crisis of confidence. The monetary base of the country flees, producing widespread fear that individuals will not be able to convert local currency to some more transportable form, such as gold or an internationally recognised hard currency.
Zimbabwe Inflation Since 1980
In neo-classical economic theory, hyperinflation is rooted in a deterioration of the monetary base; that is the confidence that there is a store of value which the currency will be able to command later. The perceived risk of holding currency rises dramatically, and sellers demand increasingly high premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse, causing even higher premiums. This is akin to trading cash with no apparent economic activity (read Cash Baron)!
Rates of inflation
of several hundred percent per month are often seen. Extreme examples
A great deal of economic literature concerns the question of what causes inflation and what effect it has. A small amount of inflation is generally viewed as having a positive effect on the economy. One reason for this is that it is difficult to renegotiate some prices, and particularly wages, downwards, so that with generally increasing prices it is easier for relative prices to adjust. Many prices are "sticky downward" and tend to creep upward, so that efforts to attain a zero inflation rate (a constant price level) punish other sectors with falling prices, profits, and employment.
Efforts to attain complete price stability can also lead to deflation, which is generally viewed as a negative because of the downward adjustments in wages and output that are associated with it. More generally, because modest inflation means that the price of any given good is likely to increase over time, there is an inherent advantage to making purchases sooner than later. This effect tends to keep an economy active in the short term by encouraging spending and borrowing, and in the long term by encouraging investments.
High inflation, though, tends to reduce long-term capital formation by hurting the incentive to save, and to effectively reduce long-term spending by making products less affordable. Limited investments will result in shortages of opportunities for corporates which will be forced into speculation. In addition, corporates become less focused on core-business as they try to survive. This can lead to corporate cannibalisation whereby companies essentially trade each other’s shares without any meaningful investment in plant, equipment, stock or capacity.
Inflation is also
viewed as a hidden risk pressure that provides an incentive for those
with savings to invest them, rather than have the purchasing power of
those savings erode through inflation. In investing, inflation risks
often cause investors to take on a more systematic risk, in order to
gain returns that will stay ahead of expected inflation. Inflation is
also used as an index for cost of living adjustments and as a peg for
some bonds. In effect, inflation is the rate at which previous economic
transactions are discounted economically.
Redistribution: Inflation will redistribute income from those on fixed incomes, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits which may keep pace with inflation -- any senior pensioner still receiving a couple of thousand Zimbabwe dollars being a clear example. Similarly, it will redistribute wealth from those who lend a fixed amount of money to those who borrow. For example, where the government is a net debtor, as is usually the case, inflation will reduce this debt by redistributing money towards the government. Thus inflation is sometimes viewed as similar to a hidden tax. This discourages savings and investment, the actual tax regime becomes impossible to calculate.
International trade: If the rate of inflation is higher than that abroad, a fixed exchange rate will be undermined through a weakening balance of trade, and forex shortage will set in.
Shoe leather costs:
Because the value of cash is eroded by inflation, people will tend to
hold less cash during times of inflation. This imposes real costs, for
example in more frequent trips to the bank. (The term is a humorous
reference to the cost of replacing shoe leather worn out when walking
to the bank or hours spend trying to access cash). Firms must change
their prices more frequently, which imposes costs, for example with
restaurants having to reprint menus.
Cost-push inflation: Presently termed "supply shock inflation," 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.
induced by adaptive expectations, often linked to the "price/wage
spiral" because it involves workers trying to keep their wages
up with prices and then employers passing higher costs on to consumers
as higher prices as part of a "vicious circle." Built-in inflation
reflects events in the past, and so might be seen as hangover inflation.
All these factors are now at play in Zimbabwe, its now impossible to
separate what is causing what.
A core assertion
of rational expectations theory is that market participants will seek
to “head off” central-bank decisions by acting in ways that
fulfil predictions of higher inflation. This means that central banks
must establish their credibility in fighting inflation, or have economic
actors make bets that the economy will expand, believing that the central
bank will expand the money supply rather than allow a recession. But
when you promise to withdraw a high value note only to say “I
was just joking”, that won’t do much to build a solid reputation.
In Zimbabwe, however, monetary policy has ceased to be a useful management tool. The inflation is at 24 000 %, the RBZ borrows through treasury bills at 340% then on-lends the money at 25% .This sequence of rates is a disaster. If monetary policy was to be an effective tool, using the above numbers, the RBZ would have to borrow at slightly above 24000%, then on-lend at even higher rate say 24 050%.
High interest rates
and slow growth of the money supply are the traditional ways through
which central banks fight or prevent inflation, though they have different
approaches. For instance, some follow a symmetrical inflation target
while others only control inflation when it rises above a target, whether
express or implied. Facilities such as Baccossi are highly inflationary.
Such facilities subsidise loans and eliminate commercial banking activity
since corporates are driven to borrow from such facilities and get a
false sense of efficiency.
The usual economic
analysis is that which is under-priced is over-consumed, and that the
distortions that occur will force adjustments in supply. For example,
if the official price of bread is too low, there will be too little
bread at official prices. And your only source of bread becomes the
black market. This trend undermines the formal sector as more activity
goes underground and the government’s ability to raise revenue
The lower activity will place fewer demands on whatever commodities were driving inflation, whether labour or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed.
Price controls such
as “operation dzikisa mutengo”, whilst initially very popular,
they can ruin a nation dramatically fast.
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