Zimbabwe Inflation Essay

Introduction

Inflation can be described as a tendency for the general price level to increase over a given time [http://www.ntsearch.com/search.php?q=time&%3Bv=56] period. It can also be viewed as a case where too much money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] is chasing few goods. Inflation is usually measured by the Consumer Price Index (CPI) where a representative basket of consumer goods is analysed for changes in the price level over a defined time [http://www.ntsearch.com/search.php?q=time&%3Bv=56] frame.

Generally, inflation results from demand pull, cost push and imported inflation. Demand pull arises due to supply side bottlenecks which will be outweighed by increased demand. Cost push inflation results when manufacturers and producers of goods and services pass the increases in the costs of production to their customers and this is reflected in the price increases. Imported inflation results from increased costs in the acquisition of forex and this will be passed to the customers as higher price.

Causes of Inflation in Zimbabwe since 1999

Rise in the international oil prices

The rise in the oil prices led to general increase in prices of most commodities [http://www.ntsearch.com/search.php?q=commodities&%3Bv=56] in the country as fuel is a major input in most manufacturing and transportation sectors. The rise in the oil prices occurred in the third and fourth quarter of 1999. Zimbabwe does produce oil, so it depended on imports, so an increase in the price on the international market as result of OPEC cartel agreements, will drastically increase prices of most goods and this is a classic example of imported inflation.

Fiscal deficits

Budget deficits have been increasing more rapidly since 1997 after payment of the war-veterans gratuities which were not budgeted for in the national budget. This was followed by the entry into the DRC war which was estimated to cost billions of dollars for the two year stay. The effect of high budget deficits as well as fiscal expansion resulted in debt-trap because of higher interest payments. This could lead to printing [http://www.ntsearch.com/search.php?q=printing&%3Bv=56] of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] to finance [http://www.ntsearch.com/search.php?q=finance&%3Bv=56] some of these activities and results in inflationary environment.

Rapid Money [http://www.ntsearch.com/search.php?q=Money&%3Bv=56] supply growth

According to Milton Friedman “inflation is always and everywhere a monetary phenomenon”. The quantity theory of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] (MV=PT) leads us to agree that the growth in the quantity of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] is the primary determinant of the inflation rate since V(velocity of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] circulation) and T (the number of transactions within an economy) are assumed to be constant. This view implies that periods of high money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] growth tends to have higher inflation rates. Increase in the money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply was experienced by the involvement in the DRC war as well as the high budget deficits which are now in excess of 10% of GDP.

Property [http://www.ntsearch.com/search.php?q=Property&%3Bv=56] Price Bubble

Zimbabweans in the diaspora were investing [http://www.ntsearch.com/search.php?q=investing&%3Bv=56] in property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] such as houses [http://www.ntsearch.com/search.php?q=houses&%3Bv=56] and given the fact that there are more than 2million Zimbabweans living outside the country this created to much demand and forced the prices up. From 2001 banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] also started investing [http://www.ntsearch.com/search.php?q=investing&%3Bv=56] in property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] as a way of hedging against inflation as well as for speculative reasons and this further fuelled property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] prices.

The acquisition of property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] led to liquidity problems for most the banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] as their money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] was tied up in assets which are proving difficult to off-load quickly. People [http://www.ntsearch.com/search.php?q=People&%3Bv=56] who had properties were encouraged to spend more as they were observing their assets appreciate in value thus creating an additional aggregate demand within an economy, this has an inflationary tendency.

Land Reforms

The implementation of the land reforms or farm invasions in 1999 resulted in supply-side bottlenecks in terms of output produced. Output was low due to the disturbances in the farming sector and this was further worsened by uncertainty in relation to land-ownership rights. The uncertainty led to reduced farming activity as this led to reduced agricultural output. Demand for food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] outweighed supply and this resulted in shortages and the birth of parallel market which translated to higher prices thus contributing to inflation levels. Land reforms also initially disturbed other cash crops such as tobacco which is the major export earner for the country.

Drought

This is also another supply-side constraint that was experienced in 2001-2002 agricultural seasons. The droughts resulted in low harvests and the supply of food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] was low and this forced people [http://www.ntsearch.com/search.php?q=people&%3Bv=56] to compete for the available food [http://www.ntsearch.com/search.php?q=food&%3Bv=56]. The effect was the mushrooming of the parallel market which led to higher prices for food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] related commodities [http://www.ntsearch.com/search.php?q=commodities&%3Bv=56].

Monetary Policy

The monetary policy for 1999 and 2001 advocated for cheaper money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] with the main aim being of assisting exporters as well as other productive sectors within the economy such as construction [http://www.ntsearch.com/search.php?q=construction&%3Bv=56] and mining. This resulted in a negative real interest rate and this encouraged most firms and households to borrow very cheaply. However, this facility was abused as individuals also borrowed for consumption purposes and to some extent for speculative purposes. When interest rates are lower individuals have a tendency of consuming more and this results in the increased demand for food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] and other durable goods, and prices are likely to go up in such a case.

Wage to Wage spiral

This refers to case where one sector in the economy awards wage increments that are higher than the others, and this to other sectors demanding such an increment as well. However, the problem arises when the wage increments in all the sectors of the economy are not match [http://begin2search.com/cgi-bin//ezlclk.fcgi?id=12]ed by productivity as this tends to increase the aggregate demand which is not in line with the aggregate supply of goods and services within that economy. The mismatch of aggregate demand and aggregate supply in this case leads to shortages thus inflation. This is the case because increased wages (increases disposable income) are met with either a stagnant or even falling output.

Trade Unions

This is linked to the wage to wage spiral. In this case labour unions (ZCTU) became powerful in 1999 which resulted in the formation of MDC. They advocated for wage increases that were not matched with productivity but linked to the rate of inflation. The effect is the same as in the above explanation.

Policy Recommendations to curb inflation

Fiscal discipline

The most cited case in the Zimbabwean scenario is the payment of gratuity to the war veterans as well as the involvement in the war in the DRC which was financed to the tune of over US$30million per month for most for almost 2 years. The use of unbudgeted expenditure by governments has fuelled the inflation rate as well as increasing budget deficits. Government [http://www.ntsearch.com/search.php?q=Government&%3Bv=56] should desist from spending unbudgeted resources so as to instil financial discipline. The reduction of cabinet ministers as well as ministries will go a long time [http://www.ntsearch.com/search.php?q=time&%3Bv=56] in reducing budget deficits.

Privatisation of parastatals – could save the fiscus a reasonable amount by either commercialisation or privatisation of loss making parastatals like ZESA. The money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] raised could be channelled to the productive manufacturing and service industries. The success story of privatisation has been the commercialisation of NetOne though a lot could be done to improve the service.

Exchange Rate stabilisation and Export incentives

Exchange stabilisation – the abolishment of the 25% of export revenue surrendered at ZW$824 to US$1 will encourage exporters to continue in the export industry. If all the forex is changed at the auction [http://www.ntsearch.com/search.php?q=auction&%3Bv=56] rate, foreign exchange will be stabilised to some extent as compared to the current situation.

Export Incentives – this can take the form of “tax holidays” for Foreign direct investment [http://www.ntsearch.com/search.php?q=investment&%3Bv=56] (FDI) which will revive our export potential. Exports might be increased and this will result in more forex and this can be used to support other imports. Increased export earnings results in the appreciation of the Zimbabwean dollar and the extent of imported inflation is reduced. For local exporting companies the provision of concessionary interest rates might be of help if the facility is not abused. This kind of measure will reduce the burden of interest payment obligations and this will lead to the improvement in export earnings in the long run.

Curbing money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply growth

Money [http://www.ntsearch.com/search.php?q=Money&%3Bv=56] supply growth can be curbed by increasing the interest rates and this also calls for the abolishment of the concessional lending rates of 30% to the productive sector. High interest rates discourages speculative borrowing and consumption borrowing and this reduces the money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply growth.

Increasing the statutory reserve ratios for the banking institutions will assist in curbing money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply growth. An increase in the reserve ration reduces the amount of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] the banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] could lend. This also reduces the money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] multiplier hence money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] creation by the banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] is limited hence money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply reduced. The reduction in money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply will lead to a fall in the prices of goods and services according to the quantity theory of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56].

Structured land redistribution

Land redistributions should be done gradually so as not to drastically change the agricultural output. The process should be stopped and an evaluation and audit done so as to ascertain the number of takers as well as utilisation capacity. If this is not done planning in terms of expected hectarage and output will be biased and shortages will continue to prevail.

External relations

The view that Zimbabwe can do without international agencies (such as IMF/World Bank) is not very valid since Zimbabwe rely on single [http://www.ntsearch.com/search.php?q=single&%3Bv=56] product namely tobacco and to some extent mining sector for the export earnings. This is insufficient given the imported raw materials needed for its manufacturing sector; hence, donor support is needed to improve the balance of payment situation. External support will assist the government [http://www.ntsearch.com/search.php?q=government&%3Bv=56] in reducing its budget deficits as there is no pressure to borrow from the domestic market. If external relations are improved then other foreign owned firms would now find it favourable to invest.

What do we know about Zimbabwe and its economy? When we think about Zimbabwe, we recall the only term – hyperinflation. Zimbabwean inflation is so solid that the central bank of Zimbabwe had to make a 100 billion dollar note. As a result, Zimbabwe suffers from the strongest inflation in the world. There is hardly a country that can compete with it. Thus, many economists have become interested in the economy of Zimbabwe. They want to understand the major cause of this problem. We know that the weak economic condition of Zimbabwe is unnatural and probably artificial. This country is very rich regarding its resources and potential. However, the unskillful government of the current president Robert Mugabe cannot take advantage of the potential of his country. Unluckily, Zimbabwe is among the poorest countries in the world. Let us try to understand why.

Zimbabwe was a very powerful civilization between the 8th and 15th centuries AD. However, we know very little about the economy of that time. When we look at the 17th century, we will see that the majority of people in Zimbabwe, South Africa and other countries did not live in cities or common villages. They lived in the so-called tribes and fed themselves with the help of hunting and gathering. Therefore, it is impossible to speak about any economic flourishing at that time. The 18th century is characterized with the attempt of the creation of a powerful kingdom. In fact, this project was ruined by the growing interest of Europe in Zimbabwe. More and more white invaders came to Zimbabwe in order to settle down there. This land was attractive to them. The local people could not resist the power of the British pressure. What attracted Europeans in Zimbabwe? To begin with, it is land. European farmers moved from Europe to seize vast territories and develop agriculture there. Secondly, it is mining. When Europeans understood that Zimbabwe and surrounding countries are rich in platinum, gold and diamonds, they made it their colony. Thus, agriculture and mining had been the major fields of Zimbabwean economy by the middle of the 20th century.

If we speak about the period of Southern Rhodesia, we should say that the economy was based on production of chrome and tobacco. Unfortunately, the white population was privileged in Zimbabwe. They received land and rights while the rights of the black population were severely limited. They did not have land and equal opportunities in employment. However, the period of Rhodesian rule was useful for the economy of Zimbabwe. The country transformed from the agricultural state into one of the richest industrial giants. Due to the high level of development of the mining industry, the state possessed its own stable currency and experienced gradual economic growth. The rates of social inequality decreased and more and more people could take advantage of education and healthcare.

However, the situation changed cardinally in 1980s. Zimbabwe became an independent state on 18th April 1980. Robert Mugabe became Prime Minister. Later on, he became President in 1987. This personality is quite scandalous whereas his government exists primarily on foreign financial aid. Robert Mugabe is an authoritarian leader who conducts nationalistic policy. He planned to build socialism in Zimbabwe and criticized ‘Western lifestyle’. He began to persecute the white farmers and demonstrated his firm anti-American position. Zimbabwe was no longer a market economy whereas Mugabe chose another way of development. No wonder, the country was supported by the USSR and other socialist states. It received foreign financial aid that supported the rapid economic fall. After the collapse of the USSR the amount of aid reduced considerably. Zimbabwe remained without international support and its economy fell down to the current level.

The new president supported the policy of the total control of economy by the state. He believed that all companies, plants and factories should be nationalized. Private sector was persecuted and treated like a harmful element for economy. In 2000s 4000 white farmers were evicted from their lands. The government believed that their activity caused harm to the state. However, these households were prosperous and brought solid income into the budget. Eviction caused the further economic reduction and inflation.

Nationalized firms were supported by the state. Without doubt, these unproductive companies consumed money and gave nothing to the state. What is more, the corruptive government stole money while donating into nationalized business. No one can control the circulation of money in a nationalized company. Therefore, money is stolen from the budget and no one can accuse anybody of doing something illegal. The only victim is the people. The main idea of the rule of Robert Mugabe was to redistribute wealth from the white to the black population with the help of the means of the government-controlled economy. Doubtless, this plan could not be successful whereas the modern world lives according to the rules of the fair competition and market economy. Social instability and dictatorship of Mugabe frightened all potential foreign investors.

No one wants to invent into the unstable economy. Thus, this instability and inequality determines the current financial condition of Zimbabwe.

This article is written and produced by one of essay writing companies EffectivePapers.com.

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