ESSAY subject MACROECONOMICS 2 TOPIC HYPERINFLATION OF ZIMBABWE

Research context: -Unlike a stable inflation rate, hyperinflation is defined to be an economic situation where prices of goods and services skyrocket in a short period of time, thereby

FOREIGN TRADE UNIVERSITY IN HCM CITY

2011156060 Nguyễn Minh Duy (Leader)

2011156063 Bùi Hoàng Gia Hân

TABLE OF CONTENTS

INTRODUCTION 4

1 Research context: 4

2 Research purposes: 5

3 Research target and scope: 5

4 Research method: 5

5 Research structure: 5

CHAPTER 1: THEORETICAL BASIS 6

1 Definition of inflation 6

2 Types of inflation 6

2.1 Creeping Inflation 6

2.2 Walking Inflation 6

2.3 Galloping Inflation 7

2.4 Hyperinflation 7

3 Inflation and hyperinflation: Causes 7

3.1 Monetarist view of inflation: 7

3.2 Keynesian view of inflation 8

CHAPTER 2: THE HYPERINFLATION CRISIS IN ZIMBABWE 8

1 Context of Zimbabwe: 8

2 Causes 9

2.1 Land reform programme 9

2.2 War funds 10

2.3 Government instability 10

2.4 Hope decreasing 10

2.5 Inappropriate price control 11

3 Developments: 11

3.1 Before hyperinflation: 11

3.2 During Hyperinflation: 12

3.3 Hyperinflation to present day 14

4 Consequences 15

4.1 Decreasing the value of savings and retirement money 16

4.2 Increasing unemployment rate 16

4.3 Food crisis 16

4.4 Decreasing average life expectancy decrease 17

4.5 Population shift 17

4.6 Menu cost 17

4.7 Poor billionaires 17

5 Measures the government can and should carry out in order to help the country abstain from the current state of hyperinflation 17

5.1 Dollarization of the economy 17

5.2 Modification of economic policy and a new policy construction 18

5.3 The money supply control 18

5.4 Foreign investors attraction by eliminating corruption 19

5.5 Reduction of military spending and conflict avoidance 19

5.6 Relations-strengthen with other countries 19

CHAPTER 3: ZIMBABWE’S RESPONSE TO ITS HYPERINFLATION 20

1 Dollarization 20

2 The effect of Dollarization 21

CONCLUSION 23

REFERENCES 24

INTRODUCTION

1 Research context:

-Unlike a stable inflation rate, hyperinflation is defined to be an economic situation where prices of goods and services skyrocket in a short period of time, thereby the amount of G&S sold is declining while its value is climbing at an accelerating pace -Hyperinflation is totally capable of destroying a whole nation’s economy Along with the macro negative influences, it also impacts many political, social and humane principles

-Reported in 2008, Zimbabwe was named the second worst country to ever suffer from hyperinflation, just behind Hungary the postwar period After every 25 hours, prices were automatically doubled The government issued the most valuable cash papers which were valued at 100 thousand billion to cope up with the dire situation but it was just enough for a weekly bus ticket Besides, the monthly inflation rate of Zimbabwe was calculated to rise to 3,5 million % 50 million Zimbabwe dollars was merely affordable for an egg A loaf of bread was priced equal to buying 12 cars but 10 years ago

-In addition, the infamous global economic crisis in 2008 created a ripple of effects to almost every economy and Zimbabwe’s was not an exception Combined with the inefficient domestic economy and accumulated debts, Zimbabwe was announced to be the first country in the 21st century to endure hyperinflation Despite efforts from the government to reduce expenditure, pay off public debts by raising taxes, they still failed

to save the economy due to extended worker’s strikes Urgent national problems led the government to issue more and more cash to pay off debts for laborers, which made the hyperinflation status quo an irreversible crisis

-Acknowledge the urgency and adverse consequences caused by hyperinflation to a macro economic scenario and Zimbabwe’s in particular, our group has come to a consensus that this would be the topic for our course’s report Our work will examine the root causes of hyperinflation, disastrous repercussions and therefore withdraw some

of the lessons and experiences to illustrate how to avoid hyperinflation in an in depth manner

2 Research purposes:

-Our team will scrutinize the topic with 3 specific purposes:

 Analyze the root causes and hyperinflation’s impacts to Zimbabwe’s economy

 Examine how the government of Zimbabwe dealt with the situation

 Lessons learned to avoid hyperinflation and suggested solutions

3 Research target and scope:

-Target of the study: Hyperinflation crisis in Zimbabwe

-Scope of the study:

 Limitations of space: investigate hyperinflation’s causes, impacts and the government solution in Zimbabwe

 Limitations of time: from 2007 to 2009

 The quantitative approach: utilize the model AS-AD to analyze the theoretical causes of hyperinflation and gather information throughout the period studied to learn the crisis’s repercussions Secondary data is our team’s main source of information We look for sources, data, information from websites, magazines, channels, scientific research regarding the same issue domestically and internationally to approach the crisis in Zimbabwe

5 Research structure:

-The study comprises of 3 chapters as follows:

 Chapter 1: Theoretical base of knowledge with regards to inflation, thereby hyperinflation’s causes, impacts and solution to curb the dire situation

 Chapter 2: Analyze hyperinflation crisis in Zimbabwe in the span between 2007

to 2009

 Chapter 3: Examine how the government solved the problem and withdraw lessons and experiences on how to avoid hyperinflation

CHAPTER 1: THEORETICAL BASIS

1 Definition of inflation

-Inflation is an economic phenomenon in which the price of goods and services

continually rises as measured against a standard level of buying power, while the supply of goods and services declines as money devalues

-Inflation aims to evaluate the total impact of price changes for a diverse range of goods and services, and it provides for a single value representation of an economy's growth

in the price level of goods and services over time

-Cagan (1956) defined hyperinflation as "beginning in the month the rise in price exceeds 50 percent and as ending in the month before the monthly rise in prices drop below that amount and stays below for at least a year" This equates to an annual rate

2.2 Walking Inflation

Walking inflation ranges between 3% and 10% each year It is bad to the economy since

it accelerates economic growth People begin to buy more than they need in order to avoid paying significantly higher prices later This increasing purchasing drives demand even higher, to the point where providers are unable to keep up and neither can salaries

As a result, most basic goods and services are priced out of most people's grasp

2.3 Galloping Inflation

When inflation reaches 10% or above, it has a devastating effect on the economy Money depreciates so swiftly that business and employee earnings can't keep up with rising costs and prices As a result, foreign investors shun the nation where this occurs, depriving it of much-needed cash The economy deteriorates, and government officials lose credibility Inflationary pressures must be avoided at all costs

2.4 Hyperinflation

When prices rise by more than 50% each month, this is referred to be hyperinflation While hyperinflations are quite rare, once they start, they may quickly spiral out of control In reality, the majority of cases of hyperinflation occur when governments inflate money to fund wars

3 Inflation and hyperinflation: Causes

3.1 Monetarist view of inflation:

-An aggregate demand and aggregate supply framework is used by monetarists to explain the cause of inflation We suppose that if the money supply increases, the aggregate demand curve moves rightward, starting at a point where output is at the natural level The rate of output may rise above the natural rate Wages will rise when unemployment falls below the natural rate level, and the aggregate supply curve will quickly move leftward until the economy returns to its natural rate level The price level increased at the new equilibrium The final result of a constantly rising money supply

is a constant price increase Money growth is the only cause of inflation in monetarist analysis because the money supply is considered as the only source of shifts in the aggregate demand curve

-Monetarists use the idea of velocity of money, defined as the speed of circulation of one unit of money, to demonstrate that changes in aggregate expenditure are primarily influenced by changes in the money supply V= (P*Y) / M is the velocity determined

by dividing nominal spending P*Y by the money supply M

-By multiplying both sides by M, we obtain the exchange equation If velocity V is considered to remain constant, this equation becomes the contemporary quantity theory

of money, which describes how aggregate spending is determined Aggregate

expenditure will rise in the same proportion as the money supply grows and the velocity remains unchanged

3.2 Keynesian view of inflation

A dramatic rise in money supply, according to Keynesians, will cause the price level to climb at a rapid rate constantly There are no other causes that can lead to a significant increase in inflation Inflation cannot be caused solely by fiscal policy or supply-side phenomena A negative supply shock does indeed move the aggregate supply curve backward, resulting in output below the natural rate level and a higher price Because unemployment is higher than the natural rate, the aggregate supply curve will return to its initial position At the initial price level, the economy returns to full employment When it comes to fiscal policy, a one-shot increase in government spending results in only a temporary increase in the inflation rate when output is over full employment, not inflation that continues to rise We could have a continuous rise in the price level if government spending increased continuously, which violates Friedman's argument This argument, however, is inadequate because, as Keynesians recognize, government spending cannot continue to rise continuously

CHAPTER 2: THE HYPERINFLATION CRISIS IN ZIMBABWE

1 Context of Zimbabwe:

-Zimbabwe is a youthful country with considerable climatic and mineral resources Zimbabwe is rich in diamonds and some other minerals During the 1980s and 1990s, Zimbabwe was considered as one of the most developed and prosperous countries in Africa

-The currency of this country (Zimbabwe dollar) starting on April 15th, 1981 At first,

it was the 1, 5, 10 and 20 dollar banknotes But in the late 2000s, every Zimbabwean was paying hundreds of trillions of Zimbabwe dollars for an ordinary loaf of bread Zimbabwe's inflation had fallen to the highest level In July 2008, a glass of beer was doubled in price per hour

-The government did nothing to solve this serious problem The Reserve Bank just kept printing more and more dollars During the peak of the economic crisis in Zimbabwe in

2008, prices rose at least twice a day and people had to carry large bags of money to

buy food such as loaves of bread or bags of milk The inflation rate was so high that the Reserve Bank of Zimbabwe issued banknotes with a denomination of hundreds of trillions of dollars, which was the highest denomination in the world

-In 2009, The Minister of Finance, Patrick Chinamasa, was forced to withdraw the order

of using the only local currency for transactions because people do not use local currency in daily transactions Also during this time, the government stopped reporting the inflation indicators

-Citizens are allowed to openly use USD, EUR and South African rand for transactions and the US dollar was the most popular currency According to banks, four-fifths of transactions including transactions of domestically produced goods or payment of wages to workers and securities transactions were in US dollars Abandoning the domestic currency was a brave decision of the Zimbabwe government because they previously refused to

2 Causes

-Hyperinflation is a difficult problem to deal with By identifying possible causes of hyperinflation, we can avoid it in the near future In general, there are 3 main causes of inflation The first is demand-pull inflation when aggregate demand exceeds aggregate supply Second, cost-push inflation occurs when an increase in the cost of production reduces aggregate supply, which increases prices Finally, monetary inflation occurs when the money supply increases continuously

In this report, we will analyze deeply the causes of hyperinflation in Zimbabwe

2.1 Land reform programme

-Firstly, the main cause of hyperinflation in Zimbabwe in about 1997 - 2008 was the

"Land Reform Program"

-During its colonial period and the early years of independence, Zimbabwe experienced export activity with large-scale agricultural product export and was economically successful, second only to South Africa After independence, much of this country's productive arable land is still owned by whites

-During the 1990s, however, the government of President Robert Mugabe began transfer of ownership The Zimbabwean government redistributes land from farmers available to black farmers However, the new farmers had little experience so farmland

was managed by people with a little bit of knowledge of agriculture and related activities They struggled to maintain production on a large scale in the past

-As a result, the Land Reform Program reduced agricultural output, especially tobacco, which accounted for a third of foreign exchange earnings Wheat production that used

to be 300,000 tons in 1990 has also decreased 50,000 tons left in 2007

2.2 War funds

Next, Zimbabwe entered the Second Congo War from 1998 to 2002 The Mugabe government printed more money to help finance the war In 1998, despite the continued deterioration of the economic situation, the President sent 11,000 troops to the Democratic Republic of the Congo (DRC) to support Lauren Kabila Their entry into the war has depleted much of the country's monetary reserves, and Zimbabwe is reporting its war spending to the International Monetary Fund perhaps $22 million a month

2.3 Government instability

-A government with severe unrest will not look attractive to foreign investors Companies do not want to do business in a country that is not safe to invest in and does not have the security of asset ownership Besides the war with the Democratic Republic

of the Congo, conflicts between the ethnic Ndebele minority and the Shona majority in Mugabe have resulted in many clashes

-Whites and blacks also have conflicts It happened mainly due to the Land Reform Program Whites disagreed because they lost business ownership, so some white business owners with experience in farming left the country There is also violence to suppress opposition politicians, thereby eroding confidence in the future of the country's politics

- Common poverty and unemployment In 2007, nearly 80% of the population was below the poverty line Unemployment was also high even before hyperinflation occurred

- Higher denominations Although the Reserve Bank of Zimbabwe continuously issues higher denominations, Zimbabwe does not believe that the new currency will be more stable than the old

- Wrong economic decisions A mistake in a government's economic judgment can make people ineffective as they must focus on correcting the mistake While this harms the economy, it does not necessarily reduce the value of the currency but can harm confidence in the future

2.5 Inappropriate price control

-The government wanted to keep prices affordable for consumers and prevent rising inflation One of the things they did was impose price controls (price ceilings) on domestic goods and services This made the previous supply shortage even worse This was because when production costs such as wages, raw materials and imported goods increase, it is difficult for suppliers to continue to supply goods and services at the ceiling price, unless they sell through the black market So government price controls backfired and exacerbated actual shortages and inflation Thus, the above reasons have caused the government budget deficit to increase rapidly

-In addition, increasing government spending while tax revenue is decreasing causes the government to continuously print more money to pay for expenses and repay debt and as a result, a severe hyperinflation crisis in Zimbabwe

3 Developments:

3.1 Before hyperinflation:

-The Republic of Zimbabwe gained independence on April 18th, 1980 and their official currency was the Zimbabwean dollar Economic growth was steady during the early years of independence, so the Zimbabwean dollar was worth more than the US dollar

at the official exchange rate

-In 1997, the government launched the Land Reform Program, which was the first move

to worsen the economic situation Zimbabwe experienced a severe decline in food production and all other sectors as a result of this policy The banking industry also

collapsed, making farmers unable to borrow money The International Monetary Fund (IMF) refused to refinance and cancel debt because the IMF wanted to punish the country because it disagreed with Zimbabwe's policy of taking land from white landowners

-In addition, Zimbabwe was involved in the Second Congo War, so Robert Mugabe, President of Zimbabwe needed cash to spend on his army and pay his soldiers So, when

a government needs money, it will often try to generate income for the country through

a variety of economic strategies such as increasing exports to other countries and attracting foreign investors But Robert Mugabe had another idea that would shock the world The idea is that the government will print more money to pay off foreign debts and public servants like soldiers and policy

-Unfortunately, things have turned worse, an increase in the money supply does not equate to an increase in the productivity of the Zimbabwean economy, and only some new investments are real to create new goods In other words, citizens now need more dollars to buy the same amount of goods as before

3.2 During Hyperinflation: