Economics Assignment Part B 1

Economics Assignment Part B

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Economics Assignment Part B 2

1. Describe the money growth rate and the inflation rate in Zimbabwe since 2000. How do we know that Zimbabwes reported inflation between 2003 and 2007 is almost certainly below the true inflation rate? Answer: We have been provided with a case on Zimbabwes critical state in the years from 2003 to 2007. We can best describe Zimbabwes money growth rate and inflation rate through figure given in case analysis.

The given figure 1 displays Zimbabwes money growth rate and inflation rate in percentage terms for the year starting from 2000 to year 2007. Money Growth Rate: It can be defined as percentage rate of change in money supply from the previous period. Therefore, Money Growth Rate (t) = [Money Supply (t) Money Supply (t 1)]/ Money Supply (t 1)

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Inflation Rate: It can be defined as the percentage rate of change in the price index from the previous period. Therefore, Inflation Rate (t) = [Price Index (t) Price Index (t 1)]/ Price Index (t 1) Money Growth Rate and Inflation Rate since 2000: The money growth rate was way below at 52 percent in the year 2000. In 2001 it showed much higher rate of increase than inflation and kept on growing almost exponentially in coming years. It reached to a level of 66700 percent in the year 2007. The reported inflation rate grew slowly initially in 2000 from 56 percent to around 303 percent in the year 2005. After that, it took off and climbed to a reported 1100 percent in 2006 and around 24000 in 2007. True Inflation Rate during 2003-2007: We know from figure 1 that money growth rate was much higher than inflation rate in the years from 2003 to 2007. When people anticipate rapid inflation, they expect money to lose its value rapidly. Therefore, instead of saving money they spend all the money they have and save goods. It is logical to hold goods which will be of higher value in future than currency which is growing at the rate of thousands of percentages in a year. It leads to higher circulation of money in the market as velocity of money circulation increases. And money growth rate is not independent of velocity of circulation. The velocity of circulation has fallen from 2000 to 2007 from 6.7 to 0.6 which cannot be the case unless inflation rate is higher than what is shown. A lower velocity implies that people are hoarding more money. From the above analysis we can certainly say that Zimbabwes actual inflation rate was far above than reported rate during the period from 2003 to 2007. The actual figures as given in the case are 231 million percent a year of inflation rate for the year 2008. Such a

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high rate of inflation is the highest for any economy in the world till date and it becomes very difficult for such an economy to recover without reacting to it quickly and positively.

2. What features of the Zimbabwes economy provides a view of the cost of hyperinflation? Answer: Hyperinflation: Inflation can be defined as overall increase in general price levels of an economy. Hyperinflation is an extraordinarily high rate of inflation. This type of inflation accelerates at the rate much higher than generally comparable inflation rates around the world. Lord Keynes has called it as true inflation. This type of inflation invariably occurs after the point of full employment. Generally when prices rise consistently above 16%, it is termed as Galloping inflation or Hyperinflation. For e.g. The great inflation of Germany after first world war and Great Chinese inflation after second world war. In hyperinflation, the real value of the goods and services remain the same in terms of stable foreign currency but it increases continuously as a function of internal currency. It usually occurs when there is excess of money flowing in the economy or money growth rate is very high when compared with other countries. Money loses its real value rapidly on account of continuous inflows of money from Central Bank of the country. (Alfredo Saad-Filho; 2000) The correlation between Money Growth Rate and Inflation Rate:

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125000

2500 Money Growth Rate Inflation Rate 50

1 2000 2001 2002 2003 2004 2005 2006 2007

The bar chart shown above compares percentage rates of inflation and money growth for the eight year period of 2000 to 2007. Inflation rate in Zimbabwe rose from 56 percent in 2000 to around 112 in 2001, 199 in 2002 and 599 in 2003. It decreased to 132 in 2004 but again took off to reach 586 in 2005, 1281 in 2006 and 66212 percent in 2007. It reported inflation rate of as high as 231 million percent in 2008 which is highest till date for any country. That means every month, on an average price rise by 239 percent. A cup of coffee costs $3 in January, $10 in February, $117 in April and $4560 in July. Whereas money supply growth rate was around 52 percent in 2000 which rose to around 66700 in 2007. Causes: It results from a rapid increase in the money supply in the economy. When government keeps on printing money at regular intervals without collecting taxes to fund government activities, they require money supply to fund their investments and repay their debts. In such a scenario, price increases on account of increased government spending and it creates a vicious circle. The government produces more money and spends it in the welfare of the economy. Hence both monetary inflation and price inflation go hand in hand increasing

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rapidly. People spend all the money they have in anticipation of greater inflation rate in the future and save goods rather than money because value of money decreases with increase of money supply. This rapidly increases the velocity of money which increases price inflation which are related by the equation, MV = PY where M = money supply, V = Velocity, P = Price and Y = GDP. (Christine D. Reid; 2003) (McTaggart, D, Findlay, C & Parkin, M; 2010)

3. What policy changes would address Zimbabwes inflation problem? Explain. Answer: State of economy in 2008: Till date, Zimbabwe has recorded highest inflation rate in the world history. It was in a state of total collapse post 2008 time. During 2008, Zimbabwes inflation rate was so high that it could not be measured accurately. It was reported that inflation rate reached to as high as 231 million percent a year in 2008. Such a high level of inflation rate is unbearable for any economy. In absence of necessary corrective measures, the economy has no chances of survival and would be declared as bankrupt by the World Bank. This action further worsens the state of the economy as no country would want to continue their business with such a country. There are very few solutions to escape from the situation of hyperinflation. Hyperinflation is the state in which general price levels rise every minute and occurs due to high liquidity of money in the economy. It was also due to the fact that food production and manufacturing fell largely during the period of 2005-08 and unemployment rose to as high as 80%.

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Possible Solutions: Whatever be the solution, the governments first target should be to stop printing of excess notes to fund their spending. It is very necessary for any economy to combat hyperinflation. All the other solutions can be effective only if printing of currency is stopped. Other supporting solutions to this can be adopting a foreign stable currency so that money supply can be controlled. The government should also try to implement stricter regimes and policies to combat inflation. They should implement effective fiscal and monetary policy with controlled approach to regulate demand and supply of money in the economy. Over the period of time, they can align their economy to other foreign currency like Rand, Euro etc. Another solution could be that of continuing with their own Zimbabwean dollars but regulating it through strict policies and other measures so as to maintain its value in terms of other foreign currency. Implementing such stricter monetary and fiscal policy in such a situation of crisis is very challenging itself but it is the only way to improve on inflation rate. The government should eventually declare their currency as fixed exchange rate with US dollars or Rand and it would be accepted as domestic currency. The government should accept Zimbabwean dollars and in turn return US dollar or Rand to their citizens. They should also review fundamentals or basic blocks of their economy and should proceed in informed manner. Central bank can increase interest rate to stabilise money flowing in the economy until investment and consumption drop. They should also minimize their expenditures and find sources of external funds and foreign investments from other developed countries. These all actions would possible address Zimbabwes hyperinflation problems and would help them recover from such a crisis.

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4. Will deleting ten zeros off all prices stop Zimbabwes inflation problem? Explain. Answer: Case details: Zimbabwe was suffering from the problem of hyperinflation during five year period of 2004-2008. It recorded the highest levels of inflation rate and extremely high rate of money growth due to excessive printing of notes. The Government, to get rid of their debts and to buy foreign currency, kept on printing currency notes of higher and higher denominations. At one point of time they printed note of value 500 million dollar which had worth of only 15 Australian dollars. This means that their currency had virtually no existence. My Opinion: According to me, slashing ten zeros off all prices would have no effect on inflation, because prices are subjective to market conditions. That is, price depends only on demand and supply of particular good in market. If demand exceeds supply, than price of that commodity increases till the point where demand and supply are in equilibrium. On the other hand, if supply exceeds demand, than price of that commodity is expected to fall until a point when supply equals demand. Thus, demand and supply are self adjustable to acquire equilibrium. Therefore, when prices of all the commodities are lowered by deleting ten zeros, demand and supply are unchanged. Thus, the unit of measurement of inflation is changed with change in price but after that actual inflation rate remains the same. It would not solve Zimbabwes problems of hyperinflation. They would require other steps in other directions to combat inflation. Future Roadmap:

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The government can implement strict fiscal, monetary, economic and foreign investment policies to combat hyperinflation. After implementing such policies, they should regulate it through associate policies and switch to other stable foreign currency like EURO or Rand. They should have promoted higher levels of productions through governmental support and possible foreign direct investments. They should have liberalised their economy for other foreign players to enter in their market and develop underperforming sectors. These all steps are in line with historical hyperinflation cases of South America and other region which fought with inflation positively and are currently in a stable position. (Ragan, Christopher; Lipsey, Richard; 2008) Slashing ten zeros from commodity prices is not a logical decision but it is a step to convert their product pricing to convenient denominations of prices with lower values. The problem of hyperinflation can be best solved by taking multiple corrective actions with proper regulatory framework carried out in a step by step approach.

References:
Alfredo Saad-Filho (2000), Inflation theory: A critical literature review and a new research agenda, in Paul Zarembka (ed.) Value, Capitalist Dynamics and Money (Research in Political Economy, Volume 18), Emerald Group Publishing Limited, pp.335-362 Christine D. Reid, (2003) "An Encyclopedia of Macroeconomics", Reference Reviews, Vol. 17 Iss: 7, pp.20 20 McTaggart, D, Findlay, C & Parkin, M, (2010) Macroeconomics, 6th edn., Pearson Australia, pp 522-23. Ragan, Christopher; Lipsey, Richard (2008), Macroeconomics, Toronto, Ontario, Canada: Pearson Education Canada, p. 645

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