Increase in money supply causes inflation

26 Jan, 2018 - 00:01 0 Views
Increase in money supply causes inflation

eBusiness Weekly

Taurai Togarepi
During the period 2004 to 2008, Zimbabwe declared inflation as its country’s enemy number one with inflation running into several millions. At the end of 2008, Zimbabwe had the highest inflation figure in the world. The major causes of inflation during that period was excessive printing of money as the central bank embarked on quasi-fiscal operations amid a high budget deficit.

In February 2009, the Government adopted the multi-currency system, as the local currency was worthless with prices being adjusted several times a day.

If one looks closely at the inflation history of this country, especially following the failure of Economic Structural Adjustment Programme (ESAP), the problems points towards fiscal indiscipline, which led to high budget deficit, which was linked to declining output in some instances.

Government embarked on several projects from the period of ESAP including the agrarian reform, agriculture mechanisation etc. The land reform is a noble idea but most of the beneficiaries did not have background of farming or training resulting in serious decline in output, putting pressure on government finances.

Following the adoption of the multi-currency system in 2009, the country experienced deflation from 2014 to end of 2016.

In 2017, inflation started trending upwards with the International Monetary Fund forecasting a figure of 10 percent for the year 2018.

What can be done to stabilise the price of goods and services?

It is imperative to distinguish between symptoms and causes, as this is critical in prescribing the relevant policies. Shortages of hard currency in the formal system, which gave birth to the thriving black market, is not the root cause of increase in inflation but just a symptom of deep-rooted problems.

In economic theory, most authors agree that inflation is mainly caused by an increase in money supply and reduction in output, which perfectly fits our scenario in Zimbabwe.

The remedy to stabilise the economy is premised on reviving industry, especially the manufacturing sector, which relies on the agricultural sector for most of its raw materials.

The agriculture sector is the backbone of the economy; hence, there is need to urgently institute measures to increase hectarage under irrigation to ensure increased output.

Secondly, there is need to train farmers and offer concessionary loans meet working and capital expenditure requirements. Thirdly, there is need to set up the commodity exchange market so that farmers get a market price for their produce in order to operate profitably.

From another angle, as long as there is fiscal indiscipline, it will be very difficult to stabilise the economy especially prices.

Government should live within its means to manage the temptation of issuing Treasury Bills, which have resulted in ballooning of the electronic money balances versus the stock of physical cash in the economy.

Notwithstanding efforts to lure foreign investors, government should help facilitate concessionary loans for critical manufacturing companies to access working and capital expenditure to retool.

In addition, government should put in place legislation compelling all business to fall under a pressure group, as this will help to disseminate information on policies and best practices on running businesses.

The above measures will help in the medium to long term to bring price stability in the market. Interference by the visible hand is discouraged at this point, as this will cause serious shortages of goods.

The reduction of excise duty on fuel imports is a welcome development as government taxes constituted a significant portion in the pricing model of fuel in Zimbabwe.

Government should institute measures to boost purchasing power of consumers, as there is need to push real effective demand in the economy especially for locally produced products.

Government is confronted with the problem of inflationary expectations, which can only be treated by having a credible/realistic inflation target framework. Imported inflation may be minimised by instituting import substitution to reduce the quantum of products imported from other countries.

Finally, it is important for policy-makers to be concerned about the real and nominal effects of their actions and about the process by which policy changes are transmitted to the “real” economy.

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