Recent advances in monetary theories and practices have resulted in remarkable global price stability.1 As such, one would think that hyperinflations had been confined to historic case studies that test the limits of economic theories. Unfortunately, hyperinflations still exist in the twenty-first century. The ongoing experience of Venezuela attests to the enduring significance of hyperinflation in both policy and academic circles.
This book focuses on Zimbabwe as an illustration of how extensive the damage from hyperinflation can be.2 From 2001 to 2009, Zimbabwe experienced rates of inflation above 100 per cent annually, and from 2006 this rose to over 1500 per cent annually. It was only in April 2009, after almost ten years, the high inflation in Zimbabwe came to an end. This also marked the first time that the Zimbabwe dollar was suspended in 29 years.
The costs of such a hyperinflation episode are severe and affect a countryâs political, economic and social stability. Not only does high inflation create monetary instability, but the knock-on effects are also felt at the individual, household, firm and national level. Hyperinflation can drive households into poverty and lead to economic inefficiencies as market prices become unstable and money loses its traditional functions.
In Zimbabwe, due to hyperinflation, households saw an increase in food insecurity and faced limited access to much needed public services, including health care and education. In Chap. 2, we discuss the impact of hyperinflation on households and other sectors in Zimbabwe. What we find is that households had to use a number of different coping strategies to survive, including diversifying their income sources, selling assets and emigration. Similarly, with increasing borrowing rates, staff losses and a lack of resources, businesses and the public sector were limited in the quantity and quality of goods and services they could provide. As a result, Zimbabwe stagnated and moved backwards. Its GDP per capita in 2008 was lower than its GDP per capita in 1960.
Zimbabwe clearly illustrates how ill-conceived domestic policies can lead to hyperinflation. Starting in the 1990s, the Zimbabwean budget deficit started to grow, with expenditure growing faster than revenue. Decisions made by the government, including the passing of unbudgeted bonuses for independence war veterans and involvement in the Second Congo War, contributed to rapid expenditure growth. On the other hand, support for land appropriation in early 2000 contributed to a rapid decline in the output of the agriculture sector, which affected the governmentâs ability to generate tax from this key sector and thus increase revenue. In order to address this, the central bank printed money. All these factors contributed to hyperinflation in Zimbabwe from 2006 to 2008, dated using our newly created price series, the Composite Exchange Rate (CER).
The role that factors beyond the control of the authorities play during these episodes is of crucial importance. Hyperinflationary episodes may be triggered by external developments, which exacerbate domestic fragilities and the lack of financial resources leading to central banks resorting to printing money. In fact, the Zimbabwean government argues that its hyperinflation was driven by two such factors. First, they argue that private sector price speculation drove the hyperinflation episode. Their second explanation for hyperinflation is that the economic decline of 2000, including hyperinflation, was due to negative aid shocks and international sanctions.
Episodes of hyperinflation, including the one Zimbabwe experienced, are interesting for both economists and social scientists more generally because the causes, effects and resolution vary across episodes. Chapter 3, a substantial extension of McIndoe-Calder (2018), surveys episodes of hyperinflations from the literature across different countries. Hyperinflations were rare prior to the early twentieth century, highlighting the importance of currency convertibility in preventing hyperinflations. Other markers of hyperinflation periods are civil disorders, wars and socio-political unrest or changes. During these times, there was severe physical destruction of capital; imposition of large reparations; deterioration of economic freedoms, rule of law, civil administration and democratic accountability; and worsening living conditions. Finally, the other context in which hyperinflation occurred was when economies transition from a command economy to a more market-based system.
Through looking at past episodes of hyperinflations, we highlight that while various pre-conditions to hyperinflation exist, the underlying mechanics of hyperinflation hold across cases. Specifically, monetising budgetary shortfalls with a resulting elevation of inflationary expectations are the key conditions under which hyperinflations occur. In addition, in Chap. 3, we highlight parallels and contrasts across experiences of hyperinflation in the twentieth and twenty-first centuries, including Zimbabweâs own experience of hyperinflation.
Underlying these differences in hyperinflation episodes across countries are commonalities regarding the mechanisms at play before, during and after hyperinflation. Hyperinflation begins with a lack of fiscal space to address current spending shortfalls, leading to central banks having no choice but to print money and exploit seigniorage effects. Chapter 4 extends McIndoe-Calder (2018) substantially to provide the theoretical motivation on how hyperinflations occur. In line with this, it is important to be clear about the definition of hyperinflation we use. Taking Caganâs (1956) definition, hyperinflation begins the month when the price levels exceed 50 per cent in that month and ends the month after the price levels drop below 50 per cent. This definition of hyperinflation differs to chronic inflation in its causes, consequences and policy prescriptions. The 50 per cent in Caganâs (1956) definition of hyperinflation is arbitrary but provides a clear demarcation between when inflation is chronic and when it becomes extremely severe.
In drawing lessons from Zimbabweâs experience, it is crucial to understand the dynamics of the money demand function. Chapter 4 also provides the motivation and the economics behind money demand under hyperinflation. Using the quantity theory of money and Caganâs (1956) model of hyperinflation, we provide an overview of the conceptual framework in order to explain the causes and mechanics of hyperinflations. It is important to contextualise the supply and demand of money through hyperinflation episodes. The importance of the money demand function during hyperinflation is partly due to inflation expectations, which ultimately decide whether stabilisation policies will be effective or not. The literature highlights that a catalyst for hyperinflation is always the monetisation of government budget deficits, generating excessive money supply growth.
Central to this discussion of hyperinflation are the stabilisation programmes. Anchoring inflation expectations through policy credibility, which could manifest in the form of new currencies, or adopting a credible foreign currency, has been successful in most cases. Stabilising price levels remains the paramount concern of policy makers as hyperinflation erodes consumer purchasing power and distorts expectations of the future path of price levels. However, subduing hyperinflations must go hand in hand with fiscal reforms that prevent the monetisation of deficit spending. In academic circles, economists use such episodes to test existing theories and empirical regularities, thereby advancing the analytical frameworks used to identify the causes, effects and policy implications of hyperinflations.
In order to understand Zimbabweâs period of hyperinflation, it is important to use the theoretical framework to examine the mechanics underlying it. In Chap. 5, we lay out the empirical specification for how we will analyse the various explanations given for Zimbabweâs hyperinflation. In order to do this, a long-run money demand function is estimated for the Zimbabwean economy. This allows preliminary testing of the endogeneity between money and prices. We employ an Error Correction Model (ECM) formulation to account for the modelâs both short- and long-run dynamics. Next, in this empirical framework, we characterise deficit-financing behaviour in Zimbabwe over recent years. For our analysis, we initially run an ordinary least squares (OLS) regression. We then estimate an autoregressive distributed lag (ARDL) model (Peasaran and Shin 1999).
In order to test the explanations of hyperinflation, we construct a new price series based on a parallel-market (or black-market) rate of foreign currency in Zimbabwe. This price series includes the Parallel Rate, the World Currency Yearbook (WCY) and the Farm Compensation (FC) series. Chapter 6 provides an in-depth overview of the data used in this book, as well as how the various measures were calculated. We construct this new price series dataset in order to deflate money balances and establish an inflation series. This new price series does not suffer from the issues surrounding the domestic price series, especially the publication delays of the Consumer Price Index (CPI). As there were issues in data availability, as well as problems in fitting observations beyond January 2008, we estimate a money demand function from 1980 to 2008 for Zimbabwe. The data in our price series are monthly and are from January 1980 to early 2000. We also use data on the official consumer price index (CPI), money (M1), composite exchange rate (CER), the government budget and overseas development assistance (ODA). We measure inflation as the log difference over 12 months using monthly data.
To investigate the characteristics of the funding deficits in Zimbabwe in recent years, this book examines t...