Hyperinflation in Zimbabwe - Example

Assessment item 1- Part B: Case Study Name Lecturer Course Date I Introduction II Definitions III Analysis A) The money growth rate and the inflation rate in Zimbabwe since 2000. B) Features of the Zimbabwe’s economy that provides a view of the cost of hyperinflation C) Policy changes would address Zimbabwe’s inflation problem a) Fiscal and Monetary Policy in the AD-AS Framework (Short run) b) Fiscal and Monetary Policy in the AD-AS Framework (Long Run) D) Deleting ten zeros off all prices stop Zimbabwe’s inflation Reference List INTRODUCTION Zimbabwe inflation is perhaps the most current hyperinflation occurrence in the world in the last several decades. The hyperinflation had gripped the whole country and created apprehensions among the people and Zimbabwean resorted to barter trade. The inflation had its origin in excessive supply of money following the government’s actions in printing money in order to pay debts. The government could not cope with the financial burden of foreign debts because of which the nation had become almost bankrupt. It leads to excessive devaluation in currency and steep rise of private debts. Definitions Hyperinflation – this is a runaway inflation during which prices rise at phenomenal rates. The value money declines daily; people lose confidence in the currency; and monetary system begins to disintegrate. People revert to barter as a medium of exchange because money, which is rapidly falling in value, is unacceptable as a method of payments. Eventually the currency ceases to function as money, to be scraped. Economic growth – economic growth consist of progressive enlargement of the proportion of tertiary. Velocity of circulation- This is the average number of times a given quantity of money changes hands. Interest rates- the rate of interest on a new loan is referred to as the nominal interest rate. This is the rate of interest expressed in money terms and is known as the money rate of interest. The nominal interest rate has two components. One is the expected rate of inflation, and the other is the real interest rate. It is argued that lenders wish to be compensated for future inflation, and that the real interest rate is a reward for postponing consumption to a future date. Inflation-the efficiency with which money performs its functions is greatly dependent upon the stability of its purchasing power. Inflation, especially unanticipated inflation, adversely affects the functions of money by undermining wealth –holders` confidence in its ability to be used as a medium of exchange and a store of value. In its medium- of-exchange role, money provides wealth-holders with a convenience yield in the sense of saving time and effort in undertaking transactions. This yield will fall in a period of inflation because a progressively larger amount of money of will be needed to pay for the same quantity of goods and services. Money-holders will, therefore, suffer a loss of purchasing power. The store- of- value function is equally threatened by inflation. As the real value of money falls, wealth-holders are induced to switch to real sure on the prices of real assets and so make inflationary conditions worse. Analysis The money growth rate and the inflation rate in Zimbabwe since 2000. During the period of 2003 to 2007, the country’s money growth rate increased faster from 52% in the year 2000 to 66,700% in the year 2007.at the same period inflation grew from 56% in the year 2000 to 24,000% in the year 2007. This growth for money and inflation rate showed that the reported money growth rate was higher than inflation rate. This means that people did not value the currency as it lost value. Changes in the value of money have far- reaching effects both on the store of wealth and on the wealth producing capacity of the economy. These changes arbitrarily re-arrange the purchasing power in the hands of the people who hold it. Usually rising prices create a feeling of optimism in the early stages and all businesspersons feel greatly encouraged to make heavy profits. However, rising prices hit people with fixed incomes, i.e. government employees. In the reverse direction, falling prices produce even more depressing and disastrous results. A fluctuating money standard at one time checks and at another time over-stimulates the production of wealth. Many a time, it results in an unbalanced growth of industry and brings about booms or depressions. Speculation prevails and efficiency in production suffers. Fluctuating prices create a feeling of uncertainty about the future. Transactions in future sales or purchases cannot be made with confidence and calm flow of economic life is disturbed. The graph below shows inflation and money growth rates. From the graph, we can note that Zimbabwe was having hyperinflation although the reported inflation rates the true inflation rate. The reason why the reported inflation of between 2003 to 2007 can be said to be untrue is that the year 2008 the inflation rate was 40millon percent and the people they were the money as a faster rate and people of Zimbabwe resorted to barter trade. Features of the Zimbabwe’s economy that provides a view of the cost of hyperinflation In the Zimbabwe, the money growth rate was higher than the inflation rate at same time most people in Zimbabwe resorted to barter as a means of exchange. This met that the monitory system of the country had become in efficient and costly to the people. In the country, most people resorted to avoid some expenses such as transport to work by either sleeping at work or abandoning the job. People`s lives have been disrupted for example children were moved from private school to public schools. Emphasis has been placed on rising wage costs as a possible cause of inflation. There are a number of different versions of this view. One version is that trade unions put in for wage increases in an attempt to gain a bigger share of the national income for members, and that in doing so they take little or no account of the possible effects of their actions on the economy as a whole. In this approach, unions may be seen to be in conflict with capitalists as both groups strive to achieve bigger shares of the national income. Alternatively, each union may be seen as competing with other unions for bigger wage increases regardless of whether more inflation or more unemployment results (Government of Zimbabwe, 2009). In addition to rising wage costs, a number of other cost increases may be sources of inflationary pressure. In the Zimbabwe, it has been claimed that rising import prices have raised the cost of many fuels, raw material and semi-finished products to industry and led to wage claims because of the rising prices of imported food and consumer goods. If prices are rising, there is little a single country can do to isolate from inflationary pressure. Currency depreciation- A country with a flexible exchange rate and a persistent deficit on its balance of payments will tend to experience a depreciating currency. This will have the effect of raising the domestic price of all imported goods and, at the same time, will increase the demand for exports and import- substitutes. Policy changes would address Zimbabwe’s inflation problem Zimbabwe can make various policy changes that will enable them curb inflation. The policy that will solve Zimbabwe`s problem include control of money supply in the economy, price and income policies and credit squeeze. These policies are explained below Monetary policy- An upward movement in the bank rate may cause a corresponding movement in short term rates as a whole. If borrowing becomes more expensive, some consumers may borrow less to spend, and businesspersons may be less willing to finance stocks of materials or trade debtors. Economic activity may slow down as interest rates increase. Due to expansionary monetary policy curve shifts rightwards to LM1. New, equilibrium is set up at E1. At the new equilibrium point, output is more but rate of interest is lower than the initial equilibrium position. Here, the level of output increases to Y1 while the rate of interest goes down to R1 level (Branson, 1992, pp. 72-76) Error: Reference source not found Prices and income policy- The aim of a price policy is to secure price stability. This is very difficult to achieve. A price and income policy can be voluntary, or statutory, that is the government enforces compliance on trade unions and employers. High taxation- The effect of high taxation is to restrict purchasing power, and so, by reducing demand, to prevent rises in prices. For full effectiveness, a government must be prepared to tax to the point of a ‘true’ budget outlay for capital purpose. High taxes, however, although they have the advantage of leaving no legacy of debt and interest charges to be met in the future, may nevertheless have an adverse effect on the supply of work and private saving. Direct taxation can be used to mop up surplus purchasing power, whilst indirect taxes will make goods more expensive in the shops, so that buyers will not be able to afford them. Such a tax will of course have an inflationary effect, if the higher shop prices cause demands for greater incomes from consumers (Hubbard and Anthony, 2009). Fiscal policy - Due to an expansionary fiscal policy, IS curve shifts upwards to IS1. New, equilibrium is set at E1 at higher levels of output and rate of interest. Output level increases to Y1 and the rate of interest rises to R1. This expansionary effect of fiscal policy on the IS-LM model is shown in the figure below. Error: Reference source not found Fiscal and Monetary Policy in the AD-AS Framework (Short run) Due to expansionary fiscal policy as well as due to expansionary monetary policy, output level increases while the price level remains unchanged. It implies that, at a given price, more output is realized. This results into a shift in the AD curve from AD0 to AD1. New, equilibrium is set at E1 with higher output. However, fiscal or monetary policy cannot influence the aggregate supply curve. In the figure below, output level increases from Y0 to Y1 level. (Branson, 1992) Error: Reference source not found Fiscal and Monetary Policy in the AD-AS Framework (Long Run) In the long run, ASC is vertical. Therefore, expansionary fiscal policy or the expansionary monetary policy cannot alter the level of output. Level of output remains intact at Y0 level even after the adoption of expansionary policy, either fiscal or monetary. Error: Reference source not found (Branson, 1992, p. 131) Deleting ten zeros off all prices stop Zimbabwe’s inflation The deleting of ten zeros will not slow down inflation. This is because inflation can only be managed using proper monitory and price and income policies the remove of zero will have no effect but the stopping of printing of money will help slow down inflation in Zimbabwe (Federal Reserve Bank of Dallas, 2011). The government ones they stop printing money the money supply curve will shift from left to right when there is injection of money to the economy the supply curve shift from the right to left. The figure below shows the effect of money injection in the Zimbabwean case; When the fed increases the supply of money, the money supply curve shifts from ms1to ms2. The value of money and the price level adjust to bring supply and demand back into balance. The equilibrium moves from point A to point B. thus, when an increase in the money supply makes dollars more plentiful, the price level increases, making each dollar valuable. Now suppose that the money supply is increased to MS2, this creates an excess supply of money at the interest rate 0i. According to the Keynesian theory, firms and households will attempt to run down the excess money balances they are being forced to hold by buying bonds implies a fall in the rate of interest. As the rate of interest falls, the speculative demand for money increases. Eventually, the rate of interest will reach 0i2 at which point firms and households are induced to hold the increased money supply in speculative balances. This explanation of how the price level is determined and why it might change over time is called the quantity theory of money. According to the quantity theory, the quantity of money available in the economy determines the value of money, and growth in the quantity of money is the primary cause of inflation (Dornbusch and Fischer, 1990). Note that the major effect of the change in the money supply is on the rate of interest. National income and employment will only be affected if the fall in the rate of interest causes a rise in investment and, possibly, consumption. In the Keynesian model, consumption and investment only respond weakly to changes in the rate of interest- that is to say, they are interest-inelastic. This implies that monetary policy is not very powerful as a means of influencing output and employment (Branson, 1995). The analysis applies in reverse for a fall in the money supply. This time, firms and households find that their actual money balances are below their desired money balances. They attempt to build them up selling bonds. Taken together, however, the community cannot reduce its bond holdings and the attempt to do so only drives down bond prices and, therefore, leads to an increase in interest rates. As the interest rate rises, the speculative demand for money falls and money market equilibrium is eventually restored (Boyes and Melvin, 2008). Reference List Boyes, W. & Melvin, M., 2008. Economics. Boston: Houghton Mifflin Company Branson, WH., 1995. Macroeconomic Theory and Policy. New Delhi: Virender Kumar Arya. Dornbusch R & Fischer S, 1990. Macroeconomics. New York: McGraw Hill Federal Reserve Bank of Dallas, 2011. Globalization and Monetary Policy Institute 2011 Annual Report: Hyperinflation in Zimbabwe: http://www.dallasfed.org/assets/documents/institute/annual/2011/annual11b.pdf Government of Zimbabwe, 2009. Zimbabwe Millennium Development Goals: 2000 - 2007 Mid-Term Progress Report. A report of the Government of Zimbabwe to the United Nations Hubbard, GR. & Anthony, PO., 2009. Macroeconomics, 3e. New York: Prentice Hall. Read More