ESSAY subject MACROECONOMICS 2 TOPIC HYPERINFLATION OF ZIMBABWE

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

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

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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

1 Research context:

-Unlike a stable inflation rate, hyperinflation is defined to be an economic situationwhere prices of goods and services skyrocket in a short period of time, thereby theamount 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 withthe macro negative influences, it also impacts many political, social and humaneprinciples

-Reported in 2008, Zimbabwe was named the second worst country to ever sufferfrom hyperinflation, just behind Hungary the postwar period After every 25 hours,prices were automatically doubled The government issued the most valuable cashpapers which were valued at 100 thousand billion to cope up with the dire situationbut it was just enough for a weekly bus ticket Besides, the monthly inflation rate ofZimbabwe was calculated to rise to 3,5 million % 50 million Zimbabwe dollars wasmerely 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 toalmost every economy and Zimbabwe’s was not an exception Combined with theinefficient domestic economy and accumulated debts, Zimbabwe was announced to bethe first country in the 21st century to endure hyperinflation Despite efforts from thegovernment to reduce expenditure, pay off public debts by raising taxes, they stillfailed to save the economy due to extended worker’s strikes Urgent national problemsled the government to issue more and more cash to pay off debts for laborers, whichmade the hyperinflation status quo an irreversible crisis

-Acknowledge the urgency and adverse consequences caused by hyperinflation to amacro economic scenario and Zimbabwe’s in particular, our group has come to aconsensus that this would be the topic for our course’s report Our work will examinethe root causes of hyperinflation, disastrous repercussions and therefore withdrawsome of the lessons and experiences to illustrate how to avoid hyperinflation in an indepth manner

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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 theoreticalcauses of hyperinflation and gather information throughout the period studied to learn thecrisis’s repercussions Secondary data is our team’s main source of information We lookfor sources, data, information from websites, magazines, channels, scientific researchregarding the same issue domestically and internationally to approach the crisis inZimbabwe

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 ofgoods and services, and it provides for a single value representation of an economy'sgrowth in the price level of goods and services over time

-Cagan (1956) defined hyperinflation as "beginning in the month the rise in priceexceeds 50 percent and as ending in the month before the monthly rise in prices dropbelow 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 toavoid paying significantly higher prices later This increasing purchasing drives demandeven 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

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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 withrising 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 officialslose 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 ofcontrol In reality, the majority of cases of hyperinflation occur when governmentsinflate 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 toexplain the cause of inflation We suppose that if the money supply increases, theaggregate demand curve moves rightward, starting at a point where output is at thenatural level The rate of output may rise above the natural rate Wages will rise whenunemployment falls below the natural rate level, and the aggregate supply curve willquickly move leftward until the economy returns to its natural rate level The pricelevel increased at the new equilibrium The final result of a constantly rising moneysupply is a constant price increase Money growth is the only cause of inflation inmonetarist analysis because the money supply is considered as the only source ofshifts in the aggregate demand curve

-Monetarists use the idea of velocity of money, defined as the speed of circulation ofone unit of money, to demonstrate that changes in aggregate expenditure are primarilyinfluenced 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 isconsidered to remain constant, this equation becomes the contemporary quantitytheory of money, which describes how aggregate spending is determined Aggregate

expenditure will rise in the same proportion as the money supply grows and thevelocity 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 asignificant increase in inflation Inflation cannot be caused solely by fiscal policy orsupply-side phenomena A negative supply shock does indeed move the aggregatesupply curve backward, resulting in output below the natural rate level and a higherprice Because unemployment is higher than the natural rate, the aggregate supplycurve will return to its initial position At the initial price level, the economy returns tofull employment When it comes to fiscal policy, a one-shot increase in governmentspending results in only a temporary increase in the inflation rate when output is overfull employment, not inflation that continues to rise We could have a continuous rise

in the price level if government spending increased continuously, which violatesFriedman's argument This argument, however, is inadequate because, as Keynesiansrecognize, 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 inAfrica

-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 Zimbabweanwas 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 wasdoubled in price per hour

-The government did nothing to solve this serious problem The Reserve Bank just keptprinting 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

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

-In 2009, The Minister of Finance, Patrick Chinamasa, was forced to withdraw theorder of using the only local currency for transactions because people do not use localcurrency in daily transactions Also during this time, the government stoppedreporting the inflation indicators

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

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, Zimbabweexperienced export activity with large-scale agricultural product export and waseconomically successful, second only to South Africa After independence, much ofthis 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 toblack farmers However, the new farmers had little experience so farmland

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

-As a result, the Land Reform Program reduced agricultural output, especiallytobacco, which accounted for a third of foreign exchange earnings Wheat productionthat 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 Mugabegovernment printed more money to help finance the war In 1998, despite thecontinued deterioration of the economic situation, the President sent 11,000 troops tothe Democratic Republic of the Congo (DRC) to support Lauren Kabila Their entryinto the war has depleted much of the country's monetary reserves, and Zimbabwe isreporting its war spending to the International Monetary Fund perhaps $22 million amonth

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 anddoes not have the security of asset ownership Besides the war with the DemocraticRepublic of the Congo, conflicts between the ethnic Ndebele minority and the Shonamajority in Mugabe have resulted in many clashes

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

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

- Higher denominations Although the Reserve Bank of Zimbabwe continuously issueshigher denominations, Zimbabwe does not believe that the new currency will be morestable than the old

- Wrong economic decisions A mistake in a government's economic judgment canmake people ineffective as they must focus on correcting the mistake While this harms theeconomy, 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 risinginflation One of the things they did was impose price controls (price ceilings) ondomestic goods and services This made the previous supply shortage even worse.This was because when production costs such as wages, raw materials and importedgoods increase, it is difficult for suppliers to continue to supply goods and services atthe ceiling price, unless they sell through the black market So government pricecontrols backfired and exacerbated actual shortages and inflation Thus, the abovereasons have caused the government budget deficit to increase rapidly

-In addition, increasing government spending while tax revenue is decreasing causesthe government to continuously print more money to pay for expenses and repay debtand 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 theirofficial currency was the Zimbabwean dollar Economic growth was steady during theearly years of independence, so the Zimbabwean dollar was worth more than the USdollar 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 foodproduction and all other sectors as a result of this policy The banking industry also

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

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

-Unfortunately, things have turned worse, an increase in the money supply does notequate to an increase in the productivity of the Zimbabwean economy, and only somenew investments are real to create new goods In other words, citizens now need moredollars to buy the same amount of goods as before

3.2 During Hyperinflation:

-From the Table above, the estimated inflation rate for November 14, 2008

is 79,600,000,000%

-Prices doubled every 24 hours When prices started to rise, the government

responded by printing more money So the cycle continues and commodity prices

continue to rise Because the price was so high, the government had to print money with a higher denomination At first they printed 1 million Zimbabwe dollars, then they printed higher denominations of 100 million Then it was 10 billion and then 100 billion dollars

-In 2008, prices started to increase by thousands of percent per month, so thegovernment started printing 100 trillion dollars Zimbabweans became billionaires butthat money was worthless because basic goods were still worth billions of dollars

-In late 2008, a large bank's ATM had a data overflow error, preventing people fromwithdrawing money with too many zeros Despite some efforts to control inflation, theZimbabwe dollar was officially phased out on April 12, 2009 and in 2014 the Central

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