Case Study - Zimbabwe

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Readers Question: If inflation is too much money, too few goods then how come…..Zimbabwe has the world’s highest inflation rate, at more than 100,000%, and just one adult in five is believed to have a regular job? With no job, no money so no demand so…why inflation?

A likely explanation for the situation in Zimbabwe could be the government printing money in response to a shortage of output, and thereby increasing the money supply much faster than Real GDP.

A few years ago, national debt in Zimbabwe increased to over 100% of GDP. To finance the National Debt, the Government started printing money; but, this only devalued the value of existing money and caused prices to rise.

The inflation is also exacerbated by a shortage of supply. Because basic goods are in short supply it is easy for market prices to be increased causing a spiral effect of upwardly rising prices.

Ironically, this shortage of supply has been made worse by the imposition of price controls. These fix prices for basic goods. But, because the cost of production has been increasing faster than prices, suppliers have little incentive to supply (at least to official channels). This makes the shortage worse and therefore the likelihood of inflation stronger.

  • Note: I think that there is ‘weak demand’ rather than ‘no demand’ Some people still have the ability to buy goods; the problem is that the supply of goods is still less than the very ‘weak’ demand.

  • Also, the thing here is that there is little ‘effective demand’. i.e. people want to purchase goods, they just don’t have the necessary income to be able to do it. Leading to tragic consequences such as Funeral Costs soar

Inflation Rates in Zimbabwe

  • 2005 – 585.84%

  • 2006 – 1,281.11%

  • 2007 – 66,212.3%

  • 2008 – 231,150,888.87%

Causes of Inflation MV=PY

The Monetarist explanation of inflation is that prices are linked to growth in the Money Supply. The quantity theory of Money states MV=PY. If we assume a constant V (velocity of circulation) and Constant Y, an increase in the Money supply leads to an increase in prices. In practise, the link between the money supply and inflation is not as simplistic as this formula states; but, as a rough rule of thumb if the money supply increases by 1000% and Real GDP stays the same you can expect inflation of around 1000%

Mugabe’s Explanation of Inflation

I believe Mugabe once blamed inflation on ‘Greedy businesses’ demanding price rises. This encouraged him to set up price controls. But, as mentioned these have been ineffective in preventing inflation.

Other Mugabe supporters have tried to blame the inflation as a ‘Western Import’. Although this assertion is rather bizarre given that inflation is relatively low in Western economies.

Hyperinflation and Exchange Rate

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Hyperinflation causes a rapid decline in the value of a currency. This graph shows how inflation in Zimbabwe led to a steep decline in the value of the Zimbabwe currency.

Question related to hyperinflation in Zimbabwe

Readers Question: I do not understand the responses. If prices are rising by 1000% and unemployment is 80% then WHO is buying the goods? It cannot be the people unemployed as they would not have the money. If the answer is ‘no-one is buying the goods, hence starvation’ then why would prices be so high as if there’s no demand….

Usually in the West, inflation is caused during periods of rapid growth; it is termed demand pull inflation. However, this particular case of inflation is not caused by an economic boom, but, a collapse in the economy where the money supply is growing despite a fall in output and number of goods available.

Although unemployment is close to 80%, there are still people with money. There are many groups of workers who have rising nominal wages because the government is printing more money, but, because the output of goods is falling, the value of money is decreasing rapidly.

Basically, even if only a small % of the population has any money that is sufficient to cause inflation, if the output is falling. The real problem is that many people have more cash / money, but have declining real incomes.

Because there is a shortage of goods and the printing of more money it is inevitable that inflation occurs.

Note printing money does nothing to increase Real output, Real GDP. It is a basic economic paradox that you can’t get richer by printing more money. But, it doesn’t stop people in desperate situations trying.