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Major causes of inflation in Zimbabwe Essay


Inflation can be described as a tendency for the general price level to increase over a given time [http://www.ntsearch.com/search.php?q=time&%3Bv=56] period. It can also be viewed as a case where too much money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] is chasing few goods. Inflation is usually measured by the Consumer Price Index (CPI) where a representative basket of consumer goods is analysed for changes in the price level over a defined time [http://www.ntsearch.com/search.php?q=time&%3Bv=56] frame.

Generally, inflation results from demand pull, cost push and imported inflation. Demand pull arises due to supply side bottlenecks which will be outweighed by increased demand. Cost push inflation results when manufacturers and producers of goods and services pass the increases in the costs of production to their customers and this is reflected in the price increases. Imported inflation results from increased costs in the acquisition of forex and this will be passed to the customers as higher price.

Causes of Inflation in Zimbabwe since 1999

Rise in the international oil prices

The rise in the oil prices led to general increase in prices of most commodities [http://www.ntsearch.com/search.php?q=commodities&%3Bv=56] in the country as fuel is a major input in most manufacturing and transportation sectors. The rise in the oil prices occurred in the third and fourth quarter of 1999. Zimbabwe does produce oil, so it depended on imports, so an increase in the price on the international market as result of OPEC cartel agreements, will drastically increase prices of most goods and this is a classic example of imported inflation.

Fiscal deficits

Budget deficits have been increasing more rapidly since 1997 after payment of the war-veterans gratuities which were not budgeted for in the national budget. This was followed by the entry into the DRC war which was estimated to cost billions of dollars for the two year stay. The effect of high budget deficits as well as fiscal expansion resulted in debt-trap because of higher interest payments. This could lead to printing [http://www.ntsearch.com/search.php?q=printing&%3Bv=56] of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] to finance [http://www.ntsearch.com/search.php?q=finance&%3Bv=56] some of these activities and results in inflationary environment.

Rapid Money [http://www.ntsearch.com/search.php?q=Money&%3Bv=56] supply growth

According to Milton Friedman “inflation is always and everywhere a monetary phenomenon”. The quantity theory of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] (MV=PT) leads us to agree that the growth in the quantity of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] is the primary determinant of the inflation rate since V(velocity of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] circulation) and T (the number of transactions within an economy) are assumed to be constant. This view implies that periods of high money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] growth tends to have higher inflation rates. Increase in the money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply was experienced by the involvement in the DRC war as well as the high budget deficits which are now in excess of 10% of GDP.

Property [http://www.ntsearch.com/search.php?q=Property&%3Bv=56] Price Bubble

Zimbabweans in the diaspora were investing [http://www.ntsearch.com/search.php?q=investing&%3Bv=56] in property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] such as houses [http://www.ntsearch.com/search.php?q=houses&%3Bv=56] and given the fact that there are more than 2million Zimbabweans living outside the country this created to much demand and forced the prices up. From 2001 banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] also started investing [http://www.ntsearch.com/search.php?q=investing&%3Bv=56] in property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] as a way of hedging against inflation as well as for speculative reasons and this further fuelled property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] prices.

The acquisition of property [http://www.ntsearch.com/search.php?q=property&%3Bv=56] led to liquidity problems for most the banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] as their money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] was tied up in assets which are proving difficult to off-load quickly. People [http://www.ntsearch.com/search.php?q=People&%3Bv=56] who had properties were encouraged to spend more as they were observing their assets appreciate in value thus creating an additional aggregate demand within an economy, this has an inflationary tendency.

Land Reforms

The implementation of the land reforms or farm invasions in 1999 resulted in supply-side bottlenecks in terms of output produced. Output was low due to the disturbances in the farming sector and this was further worsened by uncertainty in relation to land-ownership rights. The uncertainty led to reduced farming activity as this led to reduced agricultural output. Demand for food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] outweighed supply and this resulted in shortages and the birth of parallel market which translated to higher prices thus contributing to inflation levels. Land reforms also initially disturbed other cash crops such as tobacco which is the major export earner for the country.


This is also another supply-side constraint that was experienced in 2001-2002 agricultural seasons. The droughts resulted in low harvests and the supply of food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] was low and this forced people [http://www.ntsearch.com/search.php?q=people&%3Bv=56] to compete for the available food [http://www.ntsearch.com/search.php?q=food&%3Bv=56]. The effect was the mushrooming of the parallel market which led to higher prices for food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] related commodities [http://www.ntsearch.com/search.php?q=commodities&%3Bv=56].

Monetary Policy

The monetary policy for 1999 and 2001 advocated for cheaper money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] with the main aim being of assisting exporters as well as other productive sectors within the economy such as construction [http://www.ntsearch.com/search.php?q=construction&%3Bv=56] and mining. This resulted in a negative real interest rate and this encouraged most firms and households to borrow very cheaply. However, this facility was abused as individuals also borrowed for consumption purposes and to some extent for speculative purposes. When interest rates are lower individuals have a tendency of consuming more and this results in the increased demand for food [http://www.ntsearch.com/search.php?q=food&%3Bv=56] and other durable goods, and prices are likely to go up in such a case.

Wage to Wage spiral

This refers to case where one sector in the economy awards wage increments that are higher than the others, and this to other sectors demanding such an increment as well. However, the problem arises when the wage increments in all the sectors of the economy are not match [http://begin2search.com/cgi-bin//ezlclk.fcgi?id=12]ed by productivity as this tends to increase the aggregate demand which is not in line with the aggregate supply of goods and services within that economy. The mismatch of aggregate demand and aggregate supply in this case leads to shortages thus inflation. This is the case because increased wages (increases disposable income) are met with either a stagnant or even falling output.

Trade Unions

This is linked to the wage to wage spiral. In this case labour unions (ZCTU) became powerful in 1999 which resulted in the formation of MDC. They advocated for wage increases that were not matched with productivity but linked to the rate of inflation. The effect is the same as in the above explanation.

Policy Recommendations to curb inflation

Fiscal discipline

The most cited case in the Zimbabwean scenario is the payment of gratuity to the war veterans as well as the involvement in the war in the DRC which was financed to the tune of over US$30million per month for most for almost 2 years. The use of unbudgeted expenditure by governments has fuelled the inflation rate as well as increasing budget deficits. Government [http://www.ntsearch.com/search.php?q=Government&%3Bv=56] should desist from spending unbudgeted resources so as to instil financial discipline. The reduction of cabinet ministers as well as ministries will go a long time [http://www.ntsearch.com/search.php?q=time&%3Bv=56] in reducing budget deficits.

Privatisation of parastatals – could save the fiscus a reasonable amount by either commercialisation or privatisation of loss making parastatals like ZESA. The money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] raised could be channelled to the productive manufacturing and service industries. The success story of privatisation has been the commercialisation of NetOne though a lot could be done to improve the service.

Exchange Rate stabilisation and Export incentives

Exchange stabilisation – the abolishment of the 25% of export revenue surrendered at ZW$824 to US$1 will encourage exporters to continue in the export industry. If all the forex is changed at the auction [http://www.ntsearch.com/search.php?q=auction&%3Bv=56] rate, foreign exchange will be stabilised to some extent as compared to the current situation.

Export Incentives – this can take the form of “tax holidays” for Foreign direct investment [http://www.ntsearch.com/search.php?q=investment&%3Bv=56] (FDI) which will revive our export potential. Exports might be increased and this will result in more forex and this can be used to support other imports. Increased export earnings results in the appreciation of the Zimbabwean dollar and the extent of imported inflation is reduced. For local exporting companies the provision of concessionary interest rates might be of help if the facility is not abused. This kind of measure will reduce the burden of interest payment obligations and this will lead to the improvement in export earnings in the long run.

Curbing money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply growth

Money [http://www.ntsearch.com/search.php?q=Money&%3Bv=56] supply growth can be curbed by increasing the interest rates and this also calls for the abolishment of the concessional lending rates of 30% to the productive sector. High interest rates discourages speculative borrowing and consumption borrowing and this reduces the money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply growth.

Increasing the statutory reserve ratios for the banking institutions will assist in curbing money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply growth. An increase in the reserve ration reduces the amount of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] the banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] could lend. This also reduces the money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] multiplier hence money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] creation by the banks [http://www.ntsearch.com/search.php?q=banks&%3Bv=56] is limited hence money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply reduced. The reduction in money [http://www.ntsearch.com/search.php?q=money&%3Bv=56] supply will lead to a fall in the prices of goods and services according to the quantity theory of money [http://www.ntsearch.com/search.php?q=money&%3Bv=56].

Structured land redistribution

Land redistributions should be done gradually so as not to drastically change the agricultural output. The process should be stopped and an evaluation and audit done so as to ascertain the number of takers as well as utilisation capacity. If this is not done planning in terms of expected hectarage and output will be biased and shortages will continue to prevail.

External relations

The view that Zimbabwe can do without international agencies (such as IMF/World Bank) is not very valid since Zimbabwe rely on single [http://www.ntsearch.com/search.php?q=single&%3Bv=56] product namely tobacco and to some extent mining sector for the export earnings. This is insufficient given the imported raw materials needed for its manufacturing sector; hence, donor support is needed to improve the balance of payment situation. External support will assist the government [http://www.ntsearch.com/search.php?q=government&%3Bv=56] in reducing its budget deficits as there is no pressure to borrow from the domestic market. If external relations are improved then other foreign owned firms would now find it favourable to invest.

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