(Tiểu luận FTU) infltion and case study of zimbabwe during 2008

MONEY SUPPLY AND INFLATION...6 The Quantity Theory of Money...6 Example:...7 CHAPTER IV.. Chapter 3: The relationship between inflation and the money supply Chapter 4: Harms and benefits

FACULTY OF FINANCE AND BANKING

A STUDY ON Inflation and a case study of Zimbabwe

CHAPTER I

MONEY………

…………1

I What is Money? 2

II Functions of Money 2

1 Medium of exchange 2

2 Store of value 2

3 Unit of account 3

CHAPTER II INFLATION 4

I Definition 4

II Measure inflation 4

1 Consumer Price Index (CPI) 4

2 Producer Price Indexes (PPI) 4

III Inflation and Interest Rate 5

CHAPTER III MONEY SUPPLY AND INFLATION 6

The Quantity Theory of Money 6

Example: 7

CHAPTER IV INFLATION: HARMS AND BENEFITS 9

I HARMS 9

1 Discourage investment 9

2 Menu costs 9

3 Inflation causes more inflation 9

4 Cost of reducing inflation 10

II BENEFITS 10

1 Increase economic productivity 10

2 Reduce unemployment 10

3 Increase economic growth 11

4 Encourage borrowing and lending 11

CHAPTER V INFLATION: EXAMPLE AND ANALYZE 12

I Case Study 12

II Analysis 12

1 Overview 12

1.Monetary policy: 19

2.Tight fiscal policy 19

3.Supply side policies 19

Policies to reduce inflation in more details 20

1.Monetary Policy 20

2.Supply Side Policies 21

3.Fiscal Policy 21

4.Exchange rate policy 21

5.Wage Control 22

6.Targeting Money Supply (Monetarism) 23

REFERENCES 24

 Course: Money and Banking

 Class: TCHE303.3

 Lecturer: Tran Thi Minh Tram

 Group number: Group 5

 Members: 8

Student Name Student Code

Nguyen Doan Viet Hung 1713340023

Nguyen Thi Cam Ha 1713340018 Nguyen Van Cuong 1713340011

Nguyen Thuy Linh 1713340032 Nguyen Tien Dat 1713340013

When you read the news on the internet or on newspaper, economistmight give us some terms and numbers to help us better understandabout the economy’s health When the terms like “Inflation” come

up, sometimes we might get confused about its meaning, some people might understand and some might not However as an junior

in economics, we understand that everyone is affected by the economy in general and by inflation in particular So today, we want

to make a report on what inflation is and present a case study on thephenomenon of hyperinflation of Zimbabwe during 2008 The report

is divided into 2 parts: Theoratical parts including the first four chapters

Chapter 1: Money and its functions.

Chapter 2: Inflation and its measurement.

Chapter 3: The relationship between inflation and the money supply

Chapter 4: Harms and benefits of inflation

The theratical parts will help you to revise your knowledge of economy and help you to better understand our case study:

Chapter 5: A case study of Zimbabwe

Chapter 6 : Solution for inflations

Due to limited time and resouces, the report might contain some mistakes, we hope that the lecturer can give us some advice and comment to help us fix the mistakes and do better for other reports

CHAPTER I MONEY

I What is Money?

 Anything that is generally accepted in payment for goods

and services or in the repayment of debts

 Money is distinct from income and wealth

II Functions of Money

1 Medium of exchange

Money's most important function is as a medium of exchange to

facilitate transactions

Without money, all transactions would have to be conducted

by barter, which involves direct exchange of one good or service foranother The difficulty with a barter system is that in order to obtain

a particular good or service from a supplier, one has to possess agood or service of equal value, which the supplier also desires In

other words, in a barter system, exchange can take place only if

there is a double coincidence of wants between two transacting

2 Store of value.

In order to be a medium of exchange, money must hold its value

over time; that is, it must be a store of value

If money could not be stored for some period of time and still remain

wants problem and therefore would not be adopted as a medium ofexchange

As a store of value, money is not unique; many other stores of valueexist, such as land, works of art, and even baseball cards andstamps Money may not even be the best store of value because it

depreciates with inflation However, money is more liquid than

most other stores of value because as a medium of exchange, it isreadily accepted everywhere Furthermore, money is an easilytransported store of value that is available in a number ofconvenient denominations

CHAPTER II INFLATION

is the percentage rate of change in prices level over time

 Inflation affects economies in various positive and negativeways The negative effects of inflation include an increase inthe opportunity cost of holding money, uncertainty over futureinflation which may discourage investment and savings, and ifinflation were rapid enough, shortages of goods as consumersbegin hoarding out of concern that prices will increase in thefuture Positive effects include reducing unemployment due tonominal wage rigidity

II Measure inflation

In North America, there are two main price indexes that measureinflation:

1 Consumer Price Index (CPI)

A measure of price changes in consumer goods and services such asgasoline, food, clothing and automobiles The CPI measures pricechange from the perspective of the purchaser U.S CPI data can befound at the Bureau of Labor Statistics

2 Producer Price Indexes (PPI)

A family of indexes that measure the average change over time inselling prices by domestic producers of goods and services PPIs

measure price change from the perspective of the seller U.S PPIdata can be found at the Bureau of Labor Statistics.

In the long run, the various PPIs and the CPI show a similar rate of inflation This is not the case in the short run, as PPIs often increase

before the CPI In general, investors follow the CPI more than thePPIs

III Inflation and Interest Rate

Inflation and interest rates are often linked, and frequently

referenced in macroeconomics Inflation refers to the rate at whichprices for goods and services rise In the United States, the interestrate, or the amount charged by lender to a borrower, is based on thefederal funds rate that is determined by the Federal Reserve(sometimes called "the Fed")

In general, as interest rates are reduced, more people are able toborrow more money The result is that consumers have more money

to spend, causing the economy to grow and inflation to increase Theopposite holds true for rising interest rates As interest rates areincreased, consumers tend to save as returns from savings arehigher With less disposable income being spent as a result of theincrease in the interest rate, the economy slows and inflationdecreases

Under a system of fractional-reserve banking, interest rates and inflation tend to be inversely correlated This relationship

forms one of the central tenets of contemporary monetary policy:

central banks manipulate short-term interest rates to affect the rate

of inflation in the economy

CHAPTER III MONEY SUPPLY AND INFLATION

Rapid increases in the money supply can be the result of poor

management by the central bank or by a decision to print money tosupport government spending

A frequent problem in developing nations is that governmentswithout stable or consistent tax collections often resort to printingmoney to finance government spending

Money becomes worthless if too much is printed.

If the Money Supply increases faster than real output then, ceteris paribus, inflation will occur.

If you print more money, the amount of goods doesn’t change

However, if you print money, households will have more cash andmore money to spend on goods If there is more money chasing thesame amount of goods, firms will just put up prices

The Quantity Theory of Money

The Quantity theory of money seeks to establish this connection withthe formula:

P = Price level

Y = National Income (T = number of transactions)

If we assume V and Y are constant in short-term, then increasingmoney supply will lead to increase in price level

Example:

Simple example to explain why printing money causes inflation:

Suppose the economy produces 1,000 units of output.

Suppose the money supply (number of notes and coins) =

$10,000

This means that the average price of the output produced will

be $10 (10,000/1000) Suppose then that the government print an extra $5,000 notes creating a total money supply of $15,000; but, the output of the economy stays at 1,000 units Effectively, people have more

cash, but, the number of goods is the same Because people

have more cash, they are willing to spend more to buy the goods in the economy.

Ceteris paribus, the price of the 1,000 units will increase to

$15 (15,000/1000) The price has increased, but, the quantity of

output stays the same People are not better off, and the value of money has decreased; e.g A $10 note buys fewer goods than previously.

Therefore, if the money supply is increased, but, the output stays the same, everything will just become more expensive.

The increase in national income will be purely monetary (nominal)

If output increased by 5% and the money supply increases by 7%.

Then inflation will be roughly 2%.

Assumptions in the above example

[In the real world, it is possible, if the government printed money,people would just decide to save the extra money and therefore,prices wouldn’t automatically rise However, to simplify the linkbetween the money supply and inflation, let us assume thatconsumers are willing to spend the extra money Also, if you expectinflation to rise, you have an incentive to spend it – rather than seethe value of your money fall.]

CHAPTER IV INFLATION: HARMS AND BENEFITS

I HARMS

1 Discourage investment

Inflation tends to discourage investment and long-term economicgrowth This is because of the uncertainty and confusion that is morelikely to occur during periods of high inflation Low inflation is said toencourage greater stability and encourage firms to take risks andinvest

3 Inflation causes more inflation

Inflation urges people to spend and invest, which in turn tends toboost inflation, creating a potentially catastrophic feedback loop Aspeople and businesses spend more quickly in an effort to reduce thetime they hold their depreciating currency, the economy finds itselfawash in cash no one particularly wants In other words, the supply

of money outstrips the demand, and the price of money – thepurchasing power of currency – falls at an ever-faster rate

Some infamous examples: Germans papering their walls with theWeimar Republic's worthless marks (1920s), Peruvian cafes raisingtheir prices multiple times a day (1980s), Zimbabwean consumershauling around wheelbarrow-loads of million- and billion-Zim dollarnotes (2000s) and Venezuelan thieves refusing even to stealbolívares (2010s).

4 Cost of reducing inflation

To restore price stability, Governments/Central Banks need to pursuedeflationary fiscal/monetary policy However, this leads to loweraggregate demand and often a recession The cost of reducinginflation – is unemployment, at least in the short-term

II BENEFITS

1 Increase economic productivity

When the economy is not running at capacity, meaning there isunused labor or resources, inflation theoretically helps increaseproduction More dollars translates to more spending, which equates

to more aggregated demand More demand, in turn, triggers moreproduction to meet that demand

Famous British economist John Maynard Keynes believed that someinflation was necessary to prevent the "Paradox of Thrift." Ifconsumer prices are allowed to fall consistently because the country

is becoming too productive, consumers learn to hold off theirpurchases to wait for a better deal The net effect of this paradox is

to reduce aggregate demand, leading to less production, layoffs and

a faltering economy

2 Reduce unemployment

The increased production stated above may lead to the need for

An other explanation is based on wage’s stickiness As wages tend to

be sticky, which means they change slowly in response to economicshifts, once inflation hits a certain rate, employers' real payroll costsfall, and firms are able to hire more workers

3 Increase economic growth

Inflation discourages saving, since the purchasing power of depositserodes over time That prospect gives consumers and businesses anincentive to spend or invest At least in the short term, the boost tospending and investment leads to economic growth Speakingabove, inflation's negative correlation with unemployment implies atendency to put more people to work, spurring growth

4 Encourage borrowing and lending

Inflation also makes it easier on debtors, who repay their loans withmoney that is less valuable than the money they borrowed Thisencourages borrowing and lending, which again increases spending

on all levels

CHAPTER V INFLATION: EXAMPLE AND ANALYZE

I Case Study Studied case: Hyperinflation in Zimbabwe during 2008

II Analysis

1 Overview

On 18 April 1980 Zimbabwe gained official independence from theUnited Kingdom under the leadership of Robert Mygabe At thattime, Zimbabwe had strong colonial infrastructure, a high level ofcohesion and an abundance of government promises of reform

People in Zimbabwe had every right to believe that Zimbabwe couldbecome one of the strongest independent African state However,due to the 2008 hyperinflation, Zimbabwe is now one of the poorestcountries in the world as life expectancy is low and malnutrition isbecoming a serious problem in this country

 The government decided to adopt Economic StructuralAdjustment Programme (ESAP) as a fix to some problems in theeconomy such as  inhibited investment and employment,constricted credit and foreign exchange and this broughtnegative effect to the Zimbabwean economy The ESAPinvolved decreasing in the government expenditure by acombination of cuts in public enterprise deficits andrationalization of public sector employment, tradeliberalization, removal of subsidies, devaluation of the localcurrency, privatization and enforcement of cost recovery in thehealth and education sectors with the hope to create a new era

of modernized competitive and export led industrialization andeconomic efficiency

 The government further implemented land reforms that aimed

at chasing white landowners and giving their pieces of lands toblack people

 The increase in money supply did not equate to an increase inproductivity in the Zimbabwean economy, and there was littlenew investment to create new goods

3 Consequences

 A dramatic increase in unemployment rates as people can nolonger afford for education, medical care resulting in doctors,nurses among other professionals joining the steady outwardmigration to neighbouring countries which offered betteremployment prospects Veterans of Zimbabwe's liberation waralso began to feel the pinch of a declining economy and toagitate government for greater monetary assistance for their