Hyperinflation in Zimbabwe

Introduction

In the field of macroeconomics, the word inflation carries with itself a negative aura, due to some of the most famous inflation cases the world has witnessed. Even though a small amount of inflation is highly necessary for economic growth, too much inflation causes a ripple effect. The famous case of hyperinflation in Zimbabwe is evidence of the same. To this date, the economy of Zimbabwe is suffering with inflation and the collateral damage it has caused in the lives of every person residing there. In this essay, we will come to see what caused this inflation and how tragically it impacted and sabotaged the banking system, eroded investment opportunities and lost all credit accessibility.

What is Inflation?

Inflation is a macroeconomic variable which accounts for the rise in prices of the goods and services in a country. Essentially inflation is when there is a hike in prices of everyday essential goods and services that consumers use over their lifetime. As prices of goods and services increase over time, without a rise in the money supply or money in the hands of consumers, the purchasing power of money decreases over time. This means that a consumer can purchase less amount of goods and services with the given income. Levels of demand help determine the economic growth in a country. Therefore, an increase in cost of living leads to reduced levels of demand and finally a decline in economic growth.

Along similar lines, Hyperinflation arises due to a prodigious increase in the rate of inflation. It results in a chaotic economy where, if one day a consumer is able to afford a product, the very next day the prices can skyrocket and it becomes unaffordable. A sizeable increase in the levels of money supply serves as a primary reason for hyperinflation in an economy. Money supply increases usually when the governing body of an economy begins printing money to pay national debts, when there is not enough production in the economy to generate enough revenue to pay these. Increase in money supply results in an increase in price levels. Along with this, Demand-Pull inflation serves as another primary reason for hyperinflation. When an economy has been expecting levels of inflation to grow over time, they try to purchase as many products as they can in the current time period due to rising prices in the future. This leads to a higher level of demand, compared to supply and this eventually leads to a price hike.

 

The case of Zimbabwe

Zimbabwe is one of the worst hit economies by hyperinflation. This landlocked country in Southern Africa, has faced inflation for over thirty years and as a result, has been a victim of extreme poverty along with spiralling unemployment. For ease of understanding, we will look at the economy of Zimbabwe in three periods.

The first period (1990 -2007)

The late 1990s saw a massive change in the land reforms of the country. Land redistribution from white ancestral farmers to black subsistence farmers for a more equal distribution between the two caused a massive supply shock. As the new black farmers had a limited skill set and past experience in this field, the levels of production went down considerably. This drop in output not only affected the levels of production in the primary sector, but also the secondary sector to where they provided raw materials. This supply shock did not generate enough income in the economy and therefore, with not much purchasing power, loans from banks also became tough to obtain.

Evidently, Zimbabwe had hit a road-block, which required intervention from the government and corrective policy measures, in order to bring the level of income and purchasing power back to its people.

                                                   

-The Implementation of the Policy

The government decided that it was best for the economy to implement a rigid expansionary Monetary policy. The new monetary policy introduced was about increasing the level of money supply in the economy and therefore, the pace at which new money was being printed in the economy, increased considerably. The increase in money supply was used as a method to tackle various oncoming issues in the economy. The first and foremost being, to finance the national debt which was primarily due to low levels of output and also because of a vast decline in the exports from the country.

With low levels of supply and unchanged demand, the prices of goods started increasing- also known as demand pull inflation. Along with a price hike, increased disposable money in the hands of people, the demand rose even higher and therefore, prices spiked up even more. This was the oncoming of the inflation they faced. Even though the government knew that increasing money supply was only a short-term solution, they felt that they had no other choice in order to keep their economy floating.

After a point, the consumers realised that their economy was in a deep inflation process and started expecting a price rise. Hence, in 1998 expecting a future rise in prices led to a majority of the labour market, protest for an increase in wages, to be able to purchase products in the near future. This increase in wages, caused a further increase in the cost of production, raising prices yet again.

In 1999, the World Bank and International Monetary Fund denied any aid to Zimbabwe based on the fact that these organisations did not agree with the policy decision taken by the government of the country. By now inflation had started rising to rates above 50%.

As the years saw an increasing rate of inflation, a lot of questions arose against the land reforms by the government which was one of the causes for this. In 2001, many western countries which were trying to provide monetary aid to Zimbabwe, withdrew from the same because of the manner in which the governing body was handling the chaotic economy. By 2003, inflation had crossed 500% and the economy was in a state of hyperinflation.

-The Consequences

With the coming of 2002, the entire economy was collapsing. The pace of rise in wages was not as fast as the rise in prices, which resulted in many consumers not being able to afford essential survival goods. A barter system attempt was not successful either due to lack of goods to exchange among the majority.

The economy faced a severe food shortage as well and needed to obtain fund food aid from the USA and Britain to feed its citizens.

The levels of investment almost vanished due to lack of credible borrowers. Banks became sceptical about giving out loans to individuals as there was no way that anyone cold afford paying back banks with the appropriate interest rate and eventually, shut down. The Reserve Bank set the real interest rate up to 100 percent due to increase in inflation rates. Therefore, 2003 saw the shutting down of numerous businesses and even higher rates of inflation.

By 2006, inflation rates had soared as high as 1000% and inflation started rising on a monthly basis and interest rates started rising above 500 percent under the orders of the Reserve Bank. In 2007, the annual inflation rate rose to above 7000% but saw a slight drop later in the year. The government credited this drop to a wage and price fixing they had attempted earlier that year.

                                     

 

The Second Period (2007 -2008)

During the years of 2007 to 2008, Zimbabwe witnessed its highest rates of inflation. It became extremely tough for its Reserve Bank to keep track of its inflation rate as it increased at such a fast pace and neither could a stable exchange rate be evaluated with its currency and an international stable currency due to so much uncertainty. Approximately, inflation rates soared to a high of 79,600,000,000% annually. The rate of inflation on a daily basis was about 98 percent, which approximately meant that prices were doubling every day. The purchasing power of money changed many times a day. The only feasible way to record any inflation was through the measure of Purchasing Power Parity.

Faced with so much precariousness in the economy, in 2009 the Zimbabwe government ordered for all businesses to officially deal in the United States Dollar. There came a halt to printing Zimbabwean Dollars at last. Consumers were actively asked to exchange their Zimbabwe currency as soon as they could because exchange rates kept changing not every week, but multiple times a day. It was in the best interest of all, to change their currency as soon as they could. Currency substitution is method for reducing the rate of inflation in an economy and promote economic growth.

                                    

The Third Period (2009 -Present)

Zimbabwe’s economy saw growth after a long time in 2009, when the GDP growth rate was at 12.02 percent from a low of -17.67 percent in 2008. The economy witnessed growth till 2013, when it dropped once again to 1.99 percent, but has been growing at a small rate ever since. In 2016, the bad economic growth was blamed on low levels of production, negligible foreign direct investment and no access to finance from other countries due to unreliability, by the finance minister.

The country has suffered an unstable and untrustworthy government for a long time. Common droughts have also been an unfortunate occurrence in the recent years, which hinder the optimum level of output in the economy. Consumers doubt that their government reveals real rates of inflation, to keep things in order.

In 2019, the government ordered everyone to shift their currency to Real Time Gross Settlement Dollars, from the 9 currencies that this economy was using for daily transactions. The latest recorded rate of inflation is 255.29 percent and is expected to be at 319.04 percent in 2020.

 

 The IS-LM model Perspective

Analysing the policy implemented by the government of Zimbabwe and understanding its effect through the IS-LM model, shows us that an increase in money supply gave birth to inflation and pushed the economy into tough times.

In the graph, we notice that an increase in money supply leads to a rightward shift in the LM curve, which increases the level of output/income. This increase in output/income translates into a shift in the aggregate demand curve which shows a subsequent increase in prices. Therefore, an increase in output leads to an increase in output demanded and therefore, an increase in prices as well. This became a cycle in the Zimbabwean economy and therefore lead to a constant battle of inflation where there was always an increase in money demand and a subsequent increase in prices.

Suggestive measures include promoting a contractionary monetary policy in the economy. This would reduce the level of money supply which would reduce the level of output. Subsequently, the aggregate demand would fall along with the prices. A drop in aggregate demand would result in unemployment, but only in the short run. In the long run, once prices stabilize at a low rate, output and employment levels would both increase to the optimum level. This is a tough choice for this economy as it already suffers with low levels of output and employment.

 

Conclusion

Zimbabwe has suffered with inflation for many years due to an unstable and defiant government along with the wrong policy measures, which have in turn only increased the level of inflation in the country. Policy implementation plays an extremely vital role in the working of an economy. The country needs to focus more on long term goals and rather avoid short term solutions which further push away the success rate of long-term planning.

 

 References

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https://mises.org/wire/return-hyperinflation-zimbabwe

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https://www.economicshelp.org/blog/390/inflation/hyper-inflation-in-zimbabwe/#:~:text=This%20graph%20shows%20how%20inflation,value%20of%20the%20Zimbabwe%20currency.&text=However%2C%20this%20particular%20case%20of,and%20number%20of%20goods%20available