UCT
SUMMERSCHOOL
2015
Monetary Policy:
Hyperinflation
to
Dollarization
1
29-30 January 2015
This is a story about a country led by an
African freedom-fighter, who:
 Had a history within the South African ANC
 Opposed the white colonial rulers of his country
 Jailed for his "terrorist" activities
 Convincingly elected to lead his country and advocated
reconciliation between blacks and whites
 "If yesterday I fought you as an enemy, today you have
become a friend (...) If yesterday you hated me, today
you cannot avoid the love that binds you to me and me
to you."
 Was overloaded with international honours (honorary
doctorates, Hunger Project Prize, Knighthood by ERII,
short-listed for Nobel Peace Prize)
2
29-30 January 2015
Which One?
3
29-30 January 2015
Zimbabwe success story
from 1980-1990
 High growth rates
 High school enrolment rates increased from 2% to 70%
 Literacy rate nearly doubled from 45% to 80%
 NY Times in 1986: "Zimbabwe under Mr. Mugabe’s
leadership remains one of Africa’s success stories. His
sensible economic policies have kept the country’s key
agricultural sector healthy. His responsible treatment of
the white remnants of colonial Rhodesia has checked
the flight of a skilled minority. Even the debilitating
relations between black tribes seem to be less tense."
4
29-30 January 2015
… And Now …
Inflation surpassed 1 billion percent in 2008;
About 90% of all Zimbabweans are unemployed
and at least 4,160 companies have closed;
more than 25% of citizens have left the country;
Male life expectancy was 58 years in 1991 vs. 45
years in 2006; Female life expectancy was 61
years in 1991 vs 34 years in 2006;
Country is no longer food self-sufficient and imports
most goods from South Africa (and China)
5
29-30 January 2015
Zimbabwe presently
unemployment estimated at close to 90%;
since 2011,
“And worst of all we can't even grow our own
food anymore; in the first six months of 2014
we imported over US$400 million worth of
groceries, most from South Africa.”
6
29-30 January 2015
UCT
SUMMERSCHOOL
2015
7
Zimbabwe Monetary
Policy:
From Hyperinflation
to
Dollarization
29-30 January 2015
What is Hyperinflation?
• Generally: Over 100% annual rate
of inflation
• Cagan’s definition: month-on-month
price increases exceeding 50%
• Hanke & Krus (2012) identify 29
episodes of hyperinflation
8
29-30 January 2015
Nature of Inflation
Increase in price for the same goods or
services, adjusted for quality.
Both a socio-political & economic issue
 Battle for income shares
The depreciation – inflation spiral
9
29-30 January 2015
Zimbabwe CPI Inflation
(12 month inflation in percent change)
10
29-30 January 2015
Zimbabwe Inflation in Context
Maximum
Country
Start date
End-date
Hungary
Aug 1945
Jul 1946
4.19 x 1016
Zimbabwe
Mar 2007
Nov 2008
7.96 x 1010
Yugoslavia
Apr 1992
Jan 1994
3.13 x 108
Republika Srpska
Apr 1992
Jan 1994
2.97 x 108
Germany
Aug 1922
Dec 1923
29,500
Greece
May 1941
Dec 1945
13,800
China
Oct 1947
May 1945
5,070
Danzig
Aug 1922
Oct 1923
2,440
Armenia
Oct 1993
Dec 1994
438
Turkmenistan
Jan 1992
Nov 1993
429
Monthly Rate--%
Source: Hanke, S and Krus, N (2012), World Hyperinflations, Cato Working Paper No 8.
11
29-30 January 2015
Other Past Hyperinflations
Post-war
 World War I (Germany)
 Post world war II (Hungary, Greece, China)
Latin America – as a result of 1980’s financial
liberalization (Peru, Bolivia, Chile, Argentina,
Brazil)
Former USSR, transition into democracy
African cases (Congo Brazzaville & DRC)
12
29-30 January 2015
Zimbabwe’s Hyperinflation:
(Lecture I)
Costs and benefits of inflation
How did it happen?
How is money created?
How was the exchange rate set?
Hyperinflation and Purchasing Power
Parity
Hyperinflation and the Quantity of
Money Theory
13
29-30 January 2015
Hyperinflation and Policy
(Lecture I)
 Was government leadership ignorant
of consequences of policy?
 Was government pursuing an
alternative strategy that went wrong?
 Was policy calculated to benefit only
a few?
14
29-30 January 2015
Hyperinflation Exit Strategy
(Lecture II)
Multi-currency dollarization exit strategy
Pros and Cons of Dollarization
Optimal Currency Area implications
Current policy issues
15
29-30 January 2015
Costs and Benefits of Inflation
16
29-30 January 2015
Costs of High Inflation
• Hurts purchasing power of those on fixed
incomes
• Raises real rate of taxation (personal and
business)
• Distorts relative prices leading to incorrect
decisions by economic agents
• May reduce short-run output and raise output
volatility
17
29-30 January 2015
Inflation and
the Interest Rate
• Inflation (or expected inflation) raises the
nominal interest rate
Nominal interest rate (R)
= expected inflation (ie ) + constant (r)
r = real interest rate
• What really counts is the real interest rate
r = R - ie
Or how much above the inflation rate you have
have to pay to borrow money.
18
29-30 January 2015
Inflation Affects the
Nominal and Real Interest Rates
• For rising or volatile Expected inflation, the real
interest rate premium ( r ) becomes larger.
• R = r + ie
• High (real) interest rates reduce investment, and
• Undermine the real value of debt (good for
debtors)
19
29-30 January 2015
Costs of High Inflation
Inflation can create real distortions in
economy and affects the real interest
rate.
20
29-30 January 2015
Benefits of Inflation
1. Seigniorage – the difference in the value
of money created by the
government/central bank and the cost of
creating that money. Often estimated as
the change in central bank base money, or
simply the change in the value of notes and
coins. Governments like seigniorage.
21
29-30
Benefits of Inflation
2. May create money illusion and help real
wages adjust downward.
%∆W - i = growth in real wages
22
29-30
Benefits of Inflation
3. Inflation allows the possibility of a negative
real interest rate (if nominal interest rate is
set below the rate of inflation), which can
be useful to stimulate the economy.
Nominal interest rate (R)
= expected inflation (ie ) + constant (r)
23
29-30 January 2015
Inflation and Money
“All inflation is a monetary phenomena”
 Must have increased money supply to have inflation
“All inflation is a government phenomena”
 Government must sanction the increased money
supply.
24
29-30 January 2015
How is Money Created?
25
29-30 January 2015
All Money Is Created by Banks
Central bank creates new money when it
makes a loan (to government or a State
Owned Enterprise)
The Central bank reduces the money supply
when it sells foreign exchange (reduces its
foreign reserves)
Commercial banks have a money multiplier
for the loans they make (to private sector and
government)
26
29-30 January 2015
Central Bank’s Balance Sheet
Assets
Liabilities
Foreign Assets, net
(=foreign reserves)
CIC
Credit to government
(net)
Currency in circulation
Net asset position with
banks - Open market
operations (OMO)
Banks’ deposits
(reserves)
Total Assets
In banks
Reserve Money
 Total Central Bank Liabilities = Reserve Money
or Base Money or High Powered Money
11-27
29-30 January 2015
Commercial Banks’ Balance Sheet
Assets
Liabilities
Cash (in vault)
Demand deposits
Loans to private sector
Loans to Government
(bonds)
Operations with Central
Bank (OMO)
Total Assets
11-28
Savings deposits
Money
29-30 January 2015
Money Creation
Purpose
Government
Type of Bank
Private sector
Central Bank
Commercial Banks
29
29-30 January 2015
Central Banks can Control Broad
Money through the Money Multiplier
mm = Broad money(M3)/Reserve Money
Increasing Reserve Money raises the
money supply by a multiplier effect,
which depends on reserve ratio (r) and
cash/deposit ratio (c).
(𝑐 + 1)
𝑚𝑚 =
(𝑐 + 𝑟)
30
29-30 January 2015
Zimbabwe:
Growth of Reserve Money
1,000
1,000,000,000,000,000,000,000
1,000,000,000,000,000,000
1996m1 to
2006m6
100
1,000,000,000,000,000
2006m7 to
2008m12
(right scale)
1,000,000,000,000
1,000,000,000
1,000,000
10
Jan-96
Jun-96
Nov-96
Apr-97
Sep-97
Feb-98
Jul-98
Dec-98
May-99
Oct-99
Mar-00
Aug-00
Jan-01
Jun-01
Nov-01
Apr-02
Sep-02
Feb-03
Jul-03
Dec-03
May-04
Oct-04
Mar-05
Aug-05
Jan-06
Jun-06
Nov-06
Apr-07
Sep-07
Feb'08
Jul-08
Dec-08
1,000
31
29-30 January 2015
Background to Zimbabwe’s Inflation
Why the government would
want to print money
32
29-30 January 2015
Background to Zimbabwe’s Inflation
The Congo War (1998) - Unbudgeted
Land Reform-Old problem, shifted approach
 Farm mechanization
Political Challenge – rise of MDC in 1999
Incentive for government to print money
33
29-30 January 2015
Structure of Zimbabwe’s
Foreign Exchange Markets (>2000)
Multiple Exchange Rates:
1. Official RZB rate (overvalued)
2. Parallel market rate (supply-demand)
3. UN Rate (PPP)
4. Rate for notes differed to rate for
deposits
5. “Old Mutual Rate”
34
29-30 January 2015
Official versus Parallel Market
35
Parallel rate
Offical rate
Jan-98
May…
Sep-…
Jan-99
May…
Sep-…
Jan-00
May…
Sep-…
Jan-01
May…
Sep-…
Jan-02
May…
Sep-…
Jan-03
May…
Sep-…
Jan-04
May…
Sep-…
Jan-05
May…
Sep-…
Jan-06
May…
Sep-…
Jan-07
May…
Sep-…
Jan-08
May…
Sep-…
1.E+22
1.E+21
1.E+20
1.E+19
1.E+18
1.E+17
1.E+16
1.E+15
1.E+14
1.E+13
1.E+12
1.E+11
1.E+10
1.E+09
1.E+08
1.E+07
1.E+06
1.E+05
1.E+04
1.E+03
1.E+02
1.E+01
1.E+00
29-30 January 2015
Jan-98
May-98
Sep-98
Jan-99
May-99
Sep-99
Jan-00
May-00
Sep-00
Jan-01
May-01
Sep-01
Jan-02
May-02
Sep-02
Jan-03
May-03
Sep-03
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
Parallel Market Premium
1.E+04
Log of Parallel Market Exchange Rate Premium
( >1 means more depreciated parallel rate)
1.E+03
Spread: Parallel/Official
1.E+02
1.E+01
1.E+00
1.E-01
1.E-02
36
29-30 January 2015
Hyperinflation and
Economic Behaviour
How do economic agents behave in the face
of hyperinflation?




37
Do they invest?
Do they save?
Do they speculate?
Do they spend money rapidly?
29-30 January 2015
Exchange Rate Arbitrage
Buying dollars in the official market and
selling them in the parallel market
Buying dollars for Z$ cash and selling them
for Z$ deposits
Barter may be better than cash
38
29-30 January 2015
Exchange Rate Arbitrage
Winners and Losers
What is the impact of large profits on
exchange rate arbitrage if GDP is static?
Would you consider these “rents”?
39
29-30 January 2015
What Is Money?
Money serves as:
1. Means of payment
2. Measure of value
3. Store of wealth
What happens to country’s money during
hyperinflation?
40
29-30 January 2015
Economic theory behind money,
prices and the exchange rate
41
29-30 January 2015
Inflation – Depreciation Spiral
The level of inflation is affected by the
exchange-rate-pass-through into prices
The value of the exchange rate is determined
(affected) by purchasing power parity (PPP)
42
29-30 January 2015
Purchasing Power Parity
The purchasing power parity relationship – that
prices are equalized across countries – is based on:
The “Law of one price”
P = NER Pf (for a single good)
Then for a basket of goods:
NERppp = K P/Pf (aggregate price level)
 NERppp is the equilibrium exchange rate
e = local/foreign currency; increase=depreciation
44
29-30 January 2015
Does PPP Hold?
 Tends to be a long-run phenomena after
taking account of transportation costs and
tax/tariff differentials.
 Tends to be true for traded goods as opposed
to non-traded goods
45
29-30 January 2015
Dynamic PPP
If PPP holds in terms of levels, NER = K P/Pf
Then it holds in terms of changes:
Δ%NER = Δ%K + Δ%P - Δ%Pf
Δ%NER = 0
+ idom
i.e.
- ifor
The %change in the exchange rate can be
predicted by the inflation differential
46
29-30 January 2015
The Real Exchange Rate
and Relative Prices
The real exchange rate is equivalent to the
relative prices between countries adjusted to
one currency
RER = (Rand/$*CPI_US)/CPI_SA
= (CPI_US in Rand)/(CPI_SA)
= Pus in lc/Psa
RER = (NER*Pf)/P
= NER*(Pf/P)
29-30
47January 2015
PPP and the RER
NERPPP =K*(P/Pf)
RER = NER*(Pf/P)
 If PPP always holds, then the RER is
constant (=K)
 PPP only tends to hold over the long run,
not in the short run
48 January 2015
29-30
PPP in Zimbabwe
Did Purchasing Power Parity hold?
If PPP holds:
𝑁𝐸𝑅 = 𝐾 ×
𝐶𝑃𝐼_𝑍𝐼𝑀
𝐶𝑃𝐼_𝑈𝑆
 then:
𝑅𝐸𝑅 = 𝑁𝐸𝑅 ×
𝐶𝑃𝐼_𝑈𝑆
𝐶𝑃𝐼_𝑍𝐼𝑀
is constant
If the RER is Constant, then PPP holds
Test RER for stationarity
49
29-30 January 2015
Official versus Parallel real XR
3,500
3,000
2,500
Official Rate: no unit root, Stationary
Parallel rate: no unit root, trend Stationary (real depreciation)
Real parallel market
exchange rate
2,000
1,500
1,000
Official exchange rate
500
Jan-98
May-98
Sep-98
Jan-99
May-99
Sep-99
Jan-00
May-00
Sep-00
Jan-01
May-01
Sep-01
Jan-02
May-02
Sep-02
Jan-03
May-03
Sep-03
Jan-04
May-04
Sep-04
Jan-05
May-05
Sep-05
Jan-06
May-06
Sep-06
Jan-07
May-07
Sep-07
Jan-08
May-08
Sep-08
0
50
29-30 January 2015
PPP and the Z$ Exchange Rate
Official exchange rate is stationary
Did government price at PPP?
Parallel market RER is not stationary
Hyperinflation caused real
depreciation
51
29-30 January 2015
How Does Money Affect Prices
The Quantity Theory of Money (QTM)
Mv = PQ
Money*(velocity of circulation)
= (Price level)*(Quantity Output)
52
29-30 January 2015
The Quantity Theory of Money (QTM)
Mv = PQ
In changes: %ΔM + %Δv = %ΔP + %ΔQ
Money must go somewhere:
+ %ΔP prices
%ΔM
+ %ΔQ output
- %Δv speed of circ
53
29-30 January 2015
What Happens
When Money Increases
Helicopter money experiment
Rapid increases in money in a short period
generally increase prices (inflation)
Steady consistent rises in money needed for
transactions and investment over the long-run
Acceleration of money growth will not result in
accelerating real output
54
29-30 January 2015
What is Causing What?
Money
Prices
Exchange
rate
56
29-30 January 2015
Causality
YX
Econometrics can establish correlations
Causality is a philosophical question
If lagged values of X can help predict Y above
and beyond lagged values of Y alone, then X
Granger-causes Y
57
29-30 January 2015
Common Characteristics of
Hyperinflation
Increase in velocity of money and shift to
cash vs deposits—no savings
Inability to pay foreign debt service leads to
default on debt, which eliminates ability to
borrow foreign currency in capital markets
Increase in capital controls to prevent
capital flight
Expansion of parallel markets
59
29-30 January 2015
Characteristics of Hyperinflation
Loss of confidence in the banking system, flight
to cash, which remains after hyperinflation has
been stopped; can’t afford to lend/borrow
Extreme price distortions, as government and
SOEs must price at official exchange rate, which
leads to losses.
 e.g.Could buy Air Zimbabwe plane ticket to
Emirates or Johannesburg for equivalent of $US5
changed on parallel market
Resident stop paying utility bills and taxes
60
29-30 January 2015
UCT
Zimbabwe Monetary
Policy II:
SUMMERSCHOOL
2015
61
Dollarization
29-30 January 2015
Review
Discussed the record size of the
Zimbabwe hyperinflation and the
conditions that motivated it.
Explained the nature of inflation and ifs
relationship with money and the exchange
rate: PPP and QTM
62
29-30 January 2015
What Was the
Central Bank Thinking?
Was the RBZ behaving like a
Development Bank, trying to provide
cheap financing for development?
But doing it with high powered money,
which has a large multiplier
63
29-30 January 2015
Could Zim Policy Have Worked?
Maybe in the early days (before 2006) before
the inflation-devaluation spiral
If all RBZ loans went for investment, they
might have increased GDP (Q)
[QTM: %ΔM+%Δv = %ΔP + %ΔQ]
+ %ΔP prices
%ΔM
+ %ΔQ output
- %Δv speed of circ
64
29-30 January 2015
How Do Countries Stop Hyperinflation?
Must stop inflation – devaluation spiral
Need confidence that policies that created
inflation will be stopped.
Typically slash government budget deficit
and raise interest rates
Need to replenish foreign reserves and
peg exchange rate (or use currency board)
Need support from partners like IMF/World
Bank
65
29-30 January 2015
Zim Strategy
Several attempts made at currency
reform, i.e. taking zeros off of currency,
but no serious stabilization effort.
Why was there a lack of effort by senior
policy makers for stabilization?
Private sector resorted to Dollarization
66
29-30 January 2015
What is Dollarization
Economic agents choose to hold a strong,
stable foreign currency (e.g. dollars or
euros) in place of local currency to
 protect their wealth, and
 serve as a means of payment
67
29-30 January 2015
What Does Dollarization Mean
Country is so small or so dependent on
larger partner that there is no benefit of
maintaining a separate currency; e.g.
Monaco, Costa Rica, British Virgin Islands,
Guam,…
Choice to dollarize is admission of
government inability to manage monetary
and exchange policy
68
29-30 January 2015
Types of Dollarization
Unofficial dollarization – transacting in the
foreign currency is technically illegal but
tolerated
Official dollarization – government officially
adopts use of foreign currency as the legal
tender for the country
69
29-30 January 2015
Dollarized Countries Using US Dollar










70
British Virgin Islands
Caribbean Netherlands (from 1 January 2011)
East Timor (uses its own coins
Ecuador (uses its own coins in addition to U.S. coins; Ecuador
adopted the US dollar as its legal tender in 2000.)[
El Salvador
Marshall Islands
Federated States of Micronesia (Micronesia used the US dollar
since 1944)
Palau (Palau adopted the US dollar since 1944)
Panama (uses its own coins in addition to U.S. coins. This country
has adopted the US dollar as legal tender since 1904.)
Turks and Caicos Islands
29-30 January 2015
Dollarized Countries Using Euro
 Andorra (formerly French franc and Spanish peseta
since 1278)
 Kosovo (formerly German mark and Yugoslav dinar)
 Monaco (formerly French franc since 1865; issues its
own euro coins)
 Montenegro (formerly German mark and Yugoslav dinar)
 San Marino (formerly Italian lira; issues its own euro
coins)
 Vatican City (formerly Italian lira; issues its own euro
coins)
71
29-30 January 2015
Dollarized Countries Using the Rand
Lesotho (alonside Meloti)
Namibia (alongside Namibian dollar)
(Alongside Swazi Lilangeni)
Zimbabwe (Alongside the American dollar,
Euro and Botswana pula)
72
29-30 January 2015
Zimbabwe’s Dollarization
Exit Strategy
 Dollarization was initiated by the private
sector to protect itself
 Choice of official dollarization was government
admission of inability to manage monetary
and exchange policy
 Government implemented 5-currency
dollarization (US$, €, ₤, Pula, ? ; later added
Yuan, A$)
 US dollar became default (used for
accounting)
73
29-30 January 2015
Has Zimbabwe formed a currency union with
the United States?
i.e.
Is it like another state of the USA, from an
economic point of view?
74
29-30 January 2015
How to Create Money
in A Dollarized Economy
Run a balance of payments surplus, i.e.
inflows > outflows;
Generally means that country need to have
an ongoing trade surplus
Or
Capital inflows are continuously large enough
to create an overall BOP surplus
75
29-30 January 2015
What Does the
Central Bank Do?
Central bank (RBZ) no longer has its own currency
that it can create
Zimbabwe’s Reserve Bank is broke (i.e.
liabilities>assets)
RBZ cannot be lender of last resort
RBZ cannot make loans to government
Central bank still supervises the banking system
76
29-30 January 2015
There is No Central Bank
to Manage Money Supply
Domestic banking system takes over role of creating
money based on the banking multiplier (based on
reserve ratio of 25%)
Commercial banks take over the role of central
bank regarding foreign reserves, which are now
held by the private sector
77
29-30 January 2015
Benefits and Costs of Dollarization
Benefits
Costs
 Less Xrate volatility - good
for exports
 Inflation falls to level of host
country
 Enhanced monetary
credibility
 Increased fiscal discipline
 Tends to increase
international integration
 Loss of control over
monetary policy
 Loss of seignorage revenue
 Loss of lender of last resort
by central bank
 No exchange rate shock
absorber
 Need larges amounts of
foreign reserves
78
29-30 January 2015
When is dollarization beneficial,
and what currency should be
used?
79
29-30 January 2015
Theory of Optimal Currency Areas
Countries with high trade volumes among
themselves can benefit from currency union
by reduced transactions costs
Countries subject to frequent external shocks
can benefit from monetary union (MU)
MU best with geographic proximity
High degree of labour and capital mobility is
beneficial
80
29-30 January 2015
Dollarization Currency
Even if benefits did outweigh the costs, the
question of what host currency to adopt for
dollarization remains.
81
29-30 January 2015
Optimal Currency Area Theory
Countries with high trade volumes among
themselves can benefit from currency union
by reduced transactions costs
Countries subject to frequent external shocks
can benefit from monetary union (MU)
MU works best with geographic proximity,
and
High degree of labour and capital mobility
between countries
82
29-30 January 2015
SADC and CMA Alternative
Potential future SADC monetary union
CMA Rand zone should be interesting to
Zimbabwe (SA is major trading partner)
Each member maintains a degree of
monetary autonomy
Should Zimbabwe have joined the CMA Rand
zone?
83
29-30 January 2015
What challenges has (US$)
dollarization created for
Zimbabwe?
84
29-30 January 2015
How to Increase the Money Supply
Increasing liquidity requires a balance of payments
surplus. Usually achieved through a structural
current account surplus, but …
Zimbabwe has trade deficit (25% of GDP)
But a surprising
 large positive errors and omissions, responsible for
bringing money into the country
85
29-30 January 2015
What are the Errors and Omissions
The errors and omissions reflect unaccounted
inflows, most likely from substantial
remittances from Zimbabweans in South
Africa
Other dollar cash may be leaving the country
unaccounted for and be deposited in
Botswana and South Africa.
Capital may have left Zimbabwe as private
sector reserves – these will eventually be
exhausted
86
29-30 January 2015
Is the US Dollar Good for
Zimbabwe?
Use of US dollar creates US dollar pricing, which
may be too high to make Zimbabwe internationally
competititve and create jobs.
If inflation is higher in Zimbabwe than USA, then
Zimbabwe is becoming increasingly less
competitive, i.e. it may be experiencing a real
appreciation.
How can Zim be competitive with South Africa
outside of mineral exports?
87
29-30 January 2015
Are Zimbabwe’s US Dollars Real?
Are US dollar deposits created in Zimbabwe
the same as real US dollars?
Government proposed to create a US Dollar
Treasury Bill market – can it work?
Why are dollar interest rates in Zimbabwe
so high (15%+) compared to the USA (28%)?
88
29-30 January 2015
The Investment Challenge
Country needs funds for new investment to
increase supply side, but
Domestic residents don’t have sufficient
savings to fund needed investment
Government can’t print money for investment
Indigenization Program requires 51% local
ownership, which discourages FDI
89
29-30 January 2015
Why Indigenization Program
Reduces Liquidity
Reduces amount of new investment funds
that foreigners are allowed to bring in;
For old investment, transfer of ownership
facilitates outflow of capital, e.g. mines and
banks
90
29-30 January 2015
Investment Needs and
the Interest Rate
Domestic liquidity is in short supply, but
needs rational allocation, thus high interest
rates
Lending to Zimbabwe carries high risk
premium and thus high interest rate.
So high interest rates reflect time preference?
91
29-30 January 2015
Zimbabwe’s Debt Constraint
Government would like to initiate large-scale
investment projects, but
No one (in OECD) will lend new funds to
Zimbabwe government because it is in default
on existing debt, amounting to about 150% of
GDP.
Government need debt relief package
through IMF/World Bank to resolve existing
debt, or new lenders.
92
29-30 January 2015
Can The Angola Model Work
The Angola government borrowed money
from China for investment, which was
collateralized by pledged oil production
Should (can) Zimbabwe mortgage its
untapped natural resources in the same way
by the government?
93
29-30 January 2015
Conclusions - Hyperinflation
Government chose easy strategy of high
fiscal spending financed by printing money
during 2000s
It disguised excessive fiscal spending using
(quasi-fiscal) central bank lending
Multiple exchange rates allowed insiders to
earn arbitrage profits
Main losers were those who operated in the
Zim-dollar economy
94
29-30 January 2015
Conclusions - Strategy
The government must have understood the
effects of its policies on the exchange rate,
but tried to direct the exchange rate arbitrage
profits rents to desired people (in ZANU)
95
29-30 January 2015
Conclusions - Monetary Policy
The government appeared to set the official
exchange rate based on PPP, whereas
parallel rate showed underlying real
depreciation
Evidence (from the Quantity Theory of
Money) seems to show that money growth
was directly driving the exchange rate
depreciation
96
29-30 January 2015
Conclusions – Dollarization
Dollarization appears to have been done out
of default rather than by calculation or on the
basis of Optimal Currency Area theory
The rand would appear to a better currency
for Zimbabwe than the US$
Policies to address current financial and
investment challenges are deficient
A new economic crisis could materialise
97
29-30 January 2015
Questions
1. Did dollarization produce a positive result for
Zimbabwe?
2. Who were the winners and losers in
Zimbabwe’s hyperinflation?
3. Should Zimbabwe mortgage its natural
resources with China to relaunch its
economy? (Angola Model)
4. What did Zimbabwe teach us about capital
mobility?
98
29-30 January 2015