Inflation, Money Supply and Monetary Policies in Sweden and Zimbabwe - Essay Example

A Comprehensive Study of Inflation, Money Supply & Monetary Policies in Sweden and Zimbabwe. Runaway inflation is one of the world’s largest concerns when it comes to economic matters. While the inflation in most countries is at manageable levels at the moment, history has indicated that within a very short time inflation can transform from manageable levels to unmanageable levels (Carl, 240). In light of these facts, several measures and precautions are taken by governments and other financial authorities to continuously monitor the behaviour of money in relation to its buying power very closely. The management of runaway inflation is one of the main pillars through which most governments come to power, indicating the seriousness citizens of different countries regard it. The failure to manage inflation has subsequently provided governments with tough periods, forcing some governments out of power or turning them unpopular among its citizens. Due to the heavy reliance of economies on the demand and supply dynamics, inflation becomes a headache for most countries dealing with either demand or supply inefficiencies (Carl, 248). Runaway inflations has a multitude of negative implications, the most prolific being the erosion of value and subsequent reduction in purchasing power of currency. Economists have for the longest time possible disagreed on the cause of inflation, but they agree on one thing; inflation is a result of a surplus in money supply. The result is a situation where excessive demand pushes prices of commodities to higher levels, or the excess supply of currency diminishes its value. Depreciation in the value of a currency results to a weaker currency with lesser buying power (Carl, 250). As a result, customers are forced to either cope with lesser quantity for the same value of currency or higher prices for equal quantity. The excess supply of currency and monetary equivalents is largely blamed on excessive government spending and wastage of public resources, and lack of proper management of financial institutions. Other factors blamed for increased inflation include; oil cartels, and other major players in world economies charging exorbitant prices for vital products. Since inflation is broadly defined as a concept, no concrete definition or standard formula of calculation exists. Instead, the measurement of inflation relies on various market indicators rather than standing on its own as an independent measure (Carl, 273). The basket of goods used to generate this index is comprised of basic consumption products such as food, cost of housing, transportation and energy, cost of medical insurance and health services, and other essentials to the human population. Indulgent products such as alcoholic drinks and costs of hosting parties or vacation costs do not count in the index. The exclusion of luxurious and indulgent products is due to the fact that consumers of such have a level of protection or safety from the effects of inflation (Carl, 275). As a result, the uptake of such products will not be affected by certain levels of inflation. For example an increase in the price of alcoholic products is unlikely to hinder high-income earners from consuming the product. However, an increase in the cost of fuel is likely to prevent middle-income earners from using their cars and opting for cheaper alternatives such as public transport, car-pooling or the use of a motorbike or bicycle. Since inflation is a measure of the purchasing power of currency, a variety of common consumer goods are used to develop the most widely used in its measurement. Consumer price indices are usually the result of government surveys on the prices of commodities availed for consumption. Since they are very expansive in nature, private companies cannot be relied upon to exhaust the survey. The index obtained is usually a fixed digit that cannot be defined as a rate. Furthermore, the stand-alone index does not offer any useful inferences and can only be deemed useful once it is converted into a rate. The conversion of the index into a rate is achieved by either using another index or comparing it to previous indices from other time frames. The same varieties of goods are used to develop the producer price index only that for the PPI, the prices are obtained from the producers (Carl, 278). The only difference between the two indices is that CPI measures goods ready for consumption, while PPI measures goods leaving the production facilities for distribution. The two indices are characterised by volatility and as such do not provide any meaningful inferences on inflation in the short time period (Fleming, 27). However for a longer time period, the data volatility is contained within a certain range and a trend can be deduced from the information. To deal with the volatility issues in the short run, an alternative index, known as the core rate inflation or deflation, exists. The excessive volatility in the CPI index is known to emerge from the prices of foods and energy costs (Fleming, 27). By eliminating these two from its ranks, the core rate inflation is able to provide useful information in the short run. The consumer price index is, however, the most commonly used; since using the other indices eliminates measures on other factors that influence the prices of commodities (Fleming, 27). A look at the economies of Sweden and Zimbabwe reveals very different trends in matters of inflation, and fiscal policies. What are these two countries doing so differently that they end up of different ends of the divide? Inflation rates in Sweden have been quite low and at the close of 2013, the rate went down further (Robert, 127). The major factor attributed to this trend is the decline in rates of price increases. The slow rate of increase in prices of commodities is further attributed to the fact that the economy is characterised by very weak demand for goods and services, as well as the weakening of energy prices over the past few years. These developments reduce the rate at which the costs of both consumer and producer goods increase and in return lead to low levels of inflation. Despite the favourable nature of a low inflation rate, in the case of Sweden it has some negative implications on the economy (Robert, 128). The low demand means that resource utilization in the country is relatively low and as a result, companies are operating below their optimum levels. The companies cannot attempt to utilize more resources and produce more goods since this will not be met by increasing demand and as a result, the prices will only go down further, as a result, the attempt to create demand will only lead to slower growth. Under-utilization of resources and the poor development of production costs imply that Swedish companies are experiencing periods of declining margins (Robert, 140). These declining margins weaken profitability for the companies leading to problems such as unemployment and stagnation of the economy. Reducing inflation usually translates to reducing prices and as result, most people become reluctant to purchase non-essentials expecting further drops in price in the future. Persistence of this trend usually leads countries into phases of negative growth economically, while some may even go into recessions (Robert, 142). Furthermore, the countries federal reserve insists its role is to sustain stability in the financial sector rather than offer development agendas (Robert, 143). The statement means that the regulator shall not be involved in any economic stimulus program and the economy will have to rely on itself for growth and sustainability (Robert, 143). Zimbabwe on the other hand is the exact opposite of the situation in Sweden. Over the past decade, the country has experienced an inflation rate that marvelled the entire world, leading to the overhaul of the entire fiscal structure in 2008. The country offered the world a case scenario of hyper-inflation, a situation never before witnessed in this magnitude. Due to the rapid deterioration of the currencies purchasing power, a mockery was circulating in the mass media mocking Zimbabwean currency. According to Hanke, Zimbabweans were growing stronger very fast; this was based on the fact that Z$50 worth of groceries previously required five men to carry but Z$500,000 worth of the same could now be carried by a child (p. 3). The inflation in Zimbabwe is known to have been a result of several factors involving both the country’s monetary policy and macro-economics. In the course of growing unpopularity of the current regime, it had to devise methods to sustain itself in power. To achieve this, the ruling president knew that only the military could deny the regime the opportunity to extend its rule (Hanke, 5). Therefore, the regime sought to endear itself to both the military and other disciplined forces in the country so as to consolidate its position in power. One way through which this could be accomplished is by offering them lucrative salaries and perks as incentives to support the regime. However, the country was broke due to the adoption of various policies that saw it face sanctions from the international community as well as unproductive sectors of the economy (Hanke, 6). To accomplish its goal, the regime made the worst mistake possible at the worst moment of the country’s economic status. It decided to print more money to meet the growing military and civil service wage bill. Consequently, the Zimbabwean economy was flooded with devalued currency, worsening the situation already made bad by demand pull inflation (Hanke, 7). The demand pull inflation had been a result of the government’s policy to repossess all land owned by foreigners and distribute it to the landless native citizens. The natives lacked the expertise and financial capital to make economic use of the large tracks of land in their possession. As a result, commercial farming was now reduced to small-scale farming, major factories shut down, mining activities stalled and consequently the economy collapsed (Hanke, 10). As a result, demand for basic goods such as food and clothing skyrocketed fuelled by limited supply. The costs of goods started to increase rapidly and most Zimbabweans could not cope and therefore, resulted to money laundering activities. The sanctions placed on the country made foreign trade impossible, resulting in serious shortages in foreign cash flows within the country. Instead of formulating corrective measures to stem the spiralling inflation, the government now increased salaries for its disciplined forces and civil service by an average of six hundred percent (Hanke, 12). The increased supply of currency worsened the situation as more and more cash was now chasing very few goods in a very unproductive economy. The consolidation of these problems culminated in the greatest economic hyper-inflation experienced in the country. One of the effects of this hyper-inflation is the creation of shortages as the public opts to hold on to commodities rather that currency (Hanke, 17). The change is facilitated by the perception that the value of currency held decreases with time, while the value of commodities increases. The hyper-inflation caused the depletion of national, as well as personal savings, resulting in the re-distribution of wealth. To counter the ravaging effects of hyper-inflation, the country’s reserve bank authorised the use and recognition of various foreign currencies as the countries legal tender. The move is interpreted by many as the inability of the government to manage its economy, and over-reliance on other economies instead. Unemployment and Fiscal Policies in the Two Countries. Following a financial crisis that nearly spelt doom for the Swedish economy in the early 1990s, the country sought to formulate a sound fiscal policy (Ed, 1). The policy would ensure sustainable budgeting and subsequent spending of public resources to sustain continued growth of the economy and management of both inflation and un-employment rates. The formulated policy is based on several major principles meant to enhance discipline in government spending, as well as flexibility in budgeting. One of the most effective methods through which the Swedes have managed to sustain a positive economy is through the establishment of annual expenditure limits (Ed, 1). The limits serve a vital purpose in limiting spending of surpluses achieved through sound management in previous years. The target for any particular year’s expenditure is formulated three years ahead of the actual year thus formulating a workable long term fiscal policy. The principle achieves the management of government revenues expenditure as they are generated. The move is aimed at creating reserves to cater for government expenditure during periods of economic recessions and contractions, rather than turning to borrowing (Ed, 1). Expenditure budgeting is not pushed to the expenditure limit set three years ago, it is set at a lower figure and adjusted accordingly in light of inflation and other factors affecting the economy. The move shields the government’s expenditure budget from negative implications in case of changes in economic parameters leading to increased expenditure. As a result, the government has a readily available reserve that will not require fiscal procedures to access. In addition to these policy statements, there exist a council mandated with the assessment of government policies and ensuring they are in line with the fiscal policy targets (Ed, 1). Other functions of the fiscal policy council include the proposal of changes in government policy to align them with fiscal needs of the economy as well as advising on legislation relating to fiscal matters. The continued implementation of these policies has led to the creation of one of the world’s most stable economies. The economy is characterised by continuous growth, manageable government debt and employment as well as other socioeconomic benefits for its citizens. Employment figures have continuously gone up over the last decade with only seven percent of the country’s population being classified as unemployed (Ed, 1). These successes in both fiscal policy formulation and improved economic conditions are the result of vigorous government efforts in reforming the economy so as to shield its citizens from the effects of volatility in times of uncertainty. Zimbabwe, on the other hand, seems to have a non-existent fiscal policy as it struggles to keep up with the growing needs of its citizens (Hanke, 22). The country’s economy relies heavily on external borrowing, as well as quick-fix solutions to solve long-term problems. No measures are in place to correct the under-performing economy as the government is in no position to offer any economic stimulus program for the economy. Most of the government’s budget is spent on recurrent expenses such as wages at the expense of development (Hanke, 23). The most recent budget indicated a recurrent expenditure of slightly above eighty percent of the budget raising questions on the development agenda in place for the country. In a bid to meet its expanding recurrent expenditure, the government increased taxes on the energy and telecommunications sectors, causing increased desperation of amongst Zimbabweans. The citizens are faced with diminishing cash flows, diminishing opportunities, and economy experiencing stunted growth and questionable economic policies effected by the regime (Hanke, 27). The constraints in the economy are resulting in the closure of more companies further worsening the unemployment situation which currently stands at ninety-five percent. Works cited Carl, Menger. Principles of Economics. Alabama: Luwig Von Mises Institute, 2011. Print. 230-286 Ed, Dolan. “How Smart Fiscal Rules Keep Swedens Budget In Balance.” Economonitor, 28 Nov. 2014. Web. 31 July 2011. Fleming, John Stanton. Inflation. Oxford: Oxford University Press, 2006. Print. P.136 Hanke, H. Steve. Zimbabwe: Inflation and Growth. Harare: New Zanj Publishing, 2008. Print. 56p Robert, E. Hall. Inflation: Causes and Effects. Chicago: University Of Chicago Press, 2011. Print. P.120-200. Read More