Inflation can be described as a tendency for the general price level to increase over a given time period. It can also be viewed as a case where too much money is chasing few goods. Inflation is usually measured by the Consumer Price Index (CPI) where a representative basket of consumer goods is analyzed for changes in the price level over a defined time 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.
Zimbabwe is a blessed landlocked country in southern Africa, which gained its independence from Britain on 18th April 1980. After independence the currency changed to Zimbabwe dollar from Rhodesian dollar at the par value. During the initial years the country experienced a steady upward growth and was actually seen as the bread basket of southern Africa, this continued till mid 1990s when inflation began to hit hard on Zimbabwe. Although a lot of factors are responsible for the cause of hyperinflation in Zimbabwe, the three most important ones are Land reform program, War funding and Economic Mismanagement.
McConnell and Brue (2009), define inflation as a rise in the general level of prices. When inflation occurs, each dollar of income will buy fewer goods and services than before. Inflation reduces the purchasing power of money. But inflation does not mean that all prices are rising. Even during periods of rapid inflation, some prices may be relatively constant and others may even fall. “If aggregate demand rises substantially, firms are likely to respond by raising their prices. After all, if demand is high, they can probably still sell as much as before (if not more) even at the higher prices, and thus make more profits. If firms in general put up their prices, inflation results” (Sloman and Wride 2009).
President Mugabe’s land redistribution scheme began the inflationary spiral, triggering collapses in the agricultural, banking and manufacturing sectors. As unemployment rose, the government began printing more money to increase military and government salaries. This destroyed all faith in the currency, triggering hyperinflation. Zimbabwe has experienced large scale agricultural exports and relative economic success throughout the colonial history of Zimbabwe, and through the 80’s and 90’s. Most of the country’s most productive farmland remained in white hands after independence during this time. Through the 1990s the government of Zimbabwe under the leadership of President Robert Mugabe worked to shift ownership. During the reform program most of the farm lands were taken over by local people and other government officials who had only little knowledge about the agriculture and related activities. This resulted in the declining in the production levels and by 2007, the Agricultural industry had collapsed beyond recovery. Once a net exporter of food had turned into net importer and this caused a serious impact on the economy. The country that had once provided much of the grain to the world has barely any food to put on the shelves in the supermarket. The banking sector also collapsed, with farmers unable to obtain loans for capital development. The country was not able to repay a big chunk of its loans and its debt accumulated day by day and due to this reason most of the external and internal borrowing came to a halt as no one was ready to lend them. At the peak of the crisis the government mostly depended upon the aid from other nations and international agencies.
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 of money to finance some of these activities and results in inflationary environment. In the Zimbabwean hyperinflationary case, money printing has assumed an important role as far as financing government’s expenditure activities in recent years.
Borrowing from Keynes (1920) suggestions, namely that ‘even the weakest government can enforce inflation when it can enforce nothing else’ evidence indicates that Zimbabwean government has been good at using the money machine print. For instance, the unbudgeted government expenditure of 1997 to pay the war veterans gratuities, the publicly condemned and unjustifiable Zimbabwe’s intervention in the Democratic Republic of Congo (DRC)’s war in 1998, the expenses of the controversial land reform (beginning 2000), the parliamentary (2000/2005) and presidential (2002) elections, introduction of senators in 2005 (at least 66 posts) as part of ‘widening the think tank base’ and the international payments obligations, especially since 2004, all resulted in massive money printing by the government. Above these highlighted and topical expenditure issues, the printing machines has also been the government’s ‘Messiah’ for such expenses as civil servants’ salaries.
Given the absence of central bank independence (in practice), growth of money has therefore played a significant role in the upward inflationary trend. Another important contributory factor is foreign currency black market exchange rate mainly US dollars and its resultant black market premium. Although nominal interest rates, imported inflation and external debt have also propagated hyperinflation, their influence is however minimal.
According to Milton Friedman (1992), “inflation is always and everywhere a monetary phenomenon”. The quantity theory of money (MV=PT) leads us to agree that the growth in the quantity of money is the primary determinant of the inflation rate since V(velocity of money circulation) and T (the number of transactions within an economy) are assumed to be constant. This view implies that periods of high money growth tends to have higher inflation rates. Increase in the money 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.
Furthermore, Zimbabweans in the diaspora were investing in property such as houses and given the fact that there are more than 2million Zimbabweans living outside the country this created too much demand and forced the prices up. From 2001 banks also started investing in property as a way of hedging against inflation as well as for speculative reasons and this further fuelled property prices. The acquisition of property led to liquidity problems for most the banks as their money was tied up in assets which are proving difficult to off-load quickly. People 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.
The droughts experienced in 2001 – 2002 agricultural seasons, also posed another supply-side constraint. The droughts resulted in low harvests and the supply of food was low and this forced people to compete for the available food. The effect was the mushrooming of the parallel market which led to higher prices for food related commodities. “When resources are already fully employed, the business sector cannot respond to excess demand by expanding output. So the excess demand bids up the prices of the limited output, producing demand-pull inflation.” (McConnell, Brue and Flynn 2009)
Wage to wage spiral 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 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.
What measures can Zimbabwe apply to control inflation (8)
Inflation is generally controlled by the Central Bank and/or the government. The main policy tools to control inflation include monetary policy, control of money supply, supply side policies, fiscal policy and wage controls. Higher interest rates reduce demand, leading to lower economic growth and lower inflation. Monetarists argue that there is a close link between the money supply and inflation, therefore controlling money supply can control inflation. Supply-side policies increase competitiveness and efficiency of the economy, putting downward pressure on long-term costs, a higher rate of income tax could reduce spending and inflationary pressures. Trying to control wages could, in theory, help to reduce inflationary pressures.
Monetary policy involves altering the supply of money in the economy or manipulating the rate of interest. (Sloman 2003) Monetary policy means, primarily, the control exercised over the money-creating powers of the 13,000 commercial banks in our economic system. Monetary policy affects rates of interest and the ease with which loans are obtainable, but the heart of the matter is control of the quantity of money in existence. The Reserve Bank of Zimbabwe can adopt a number of methods to control the quantity and quality of credit. For this purpose, it can raise the bank rates, sell securities in the open market, raise the reserve ratio, and adopt a number of selective credit control measures, such as raising margin requirements and regulating consumer credit. Monetary policy may not be effective in controlling inflation, if inflation is due to cost-push factors. Monetary policy can only be helpful in controlling inflation due to demand-pull factors.
However, one of the monetary measures is to demonetize currency of higher denominations. Such a measure is usually adopted when there is abundance of black money in the country. The most extreme monetary measure is the issue of new currency in place of the old currency. Under this system, one new note is exchanged for a number of notes of the old currency. The value of bank deposits is also fixed accordingly. Such a measure is adopted when there is an excessive issue of notes and there is hyperinflation in the country. It is a very effective measure. But is inequitable for its hurts the small depositors the most.
Monetary policy alone is incapable of controlling inflation. It should, therefore, be supplemented by fiscal measures. Fiscal measures are highly effective for controlling government expenditure, personal consumption expenditure, and private and public investment. “A government s fiscal policy is defined by its plans for taxes and spending. Government spending and taxation influence national income in both the short and the long run.” (Lipsey 2011)
The government should reduce unnecessary expenditure on non-development activities in order to curb inflation. This will also put a check on private expenditure, which is dependent upon government demand for goods and services. However, it is not easy to cut government expenditure. However, this measure is always welcome but it becomes difficult to distinguish between essential and non-essential expenditure. Therefore, this measure should be supplemented by taxation. To cut personal consumption expenditure, the rates of personal, corporate and commodity taxes should be raised and even new taxes should be levied, but the rates of taxes should not be so high as to discourage saving, investment and production. Rather, the tax system should provide larger incentives to those who save, invest and produce more.
Further, to bring more revenue into the tax-net, the government should penalise the tax evaders by imposing heavy fines. Such measures are bound to be effective in controlling inflation. To increase the supply of goods within the country, the government should reduce import duties and increase export duties.
Another measure is to increase savings on the part of the people. This will tend to reduce disposable income with the people, and hence personal consumption expenditure. But due to the rising cost of living, people are not in a position to save much voluntarily. Keynes, therefore, advocated compulsory savings or what he called ‘deferred payment’ where the saver gets his money back after some years. For this purpose, the government should float public loans carrying high rates of interest, start saving schemes with prize money, or lottery for long periods, etc. It should also introduce compulsory provident fund, provident fund-cum-pension schemes, etc. All such measures increase savings and are likely to be effective in controlling inflation.
At the same time, it should stop repayment of public debt and postpone it to some future date till inflationary pressures are controlled within the economy. Instead, the government should borrow more to reduce money supply with the public.
Like monetary measures, fiscal measures alone cannot help in controlling inflation. They should be supplemented by monetary, non-monetary and non-fiscal measures. Another important measure is to adopt a rational wage and income policy. Under hyperinflation, there is a wage-price spiral. To control this, the government should freeze wages, incomes, profits, dividends, bonus, etc. But such a drastic measure can only be adopted for a short period as it is likely to antagonise both workers and industrialists. Therefore, the best course is to link increase in wages to increase in productivity. This will have a dual effect. It will control wages and at the same time increase productivity, and hence raise production of goods in the economy.
In conclusion, from the various monetary, fiscal and other measures discussed above, it becomes clear that to control inflation, the government should adopt all measures simultaneously. Inflation is like a hydra- headed monster which should be fought by using all the weapons at the command of the government.