Disagreement about future inflation: Controlling inflation during structural reforms

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Samuel Mapuranga

Lackluster growth in the aftermath of November 2017 events coupled with the government’s austerity measures has renewed interest in the impact of growth-enhancing structural reforms. In addition to monetary policy, “structural reforms are key” for achieving prosperity. Structural reforms, both in less developed countries and in emerging market economies, have become associated with high rates of inflation.

The programmes aim at strengthening the institutions of the market economy and increasing the flexibility of relative prices. If prices on individual markets are allowed to adjust freely, resources will be allocated more efficiently, and a necessary foundation for sustained long-run economic growth is created. However, economic structural reforms are often introduced in situations of repressed inflation and overvalued foreign exchange rates. When prices and exchange markets are liberalised, the result is not only relative price changes but also inflation.

Zimbabwe, whose inflation rate is widely ranked as the second highest in the world is experiencing its worst economic challenges. In June 2019, annual inflation hit 175.66 percent, the highest since 2008 hyperinflation crisis that forced the country to ditch its currency in favor of a basket of currencies including the United States Dollar (US$) and the South African Rand. In August 2019, Finance Minister Mthuli Ncube suspended the publication of year–on-year inflation figures until February 2020 because adoption of a new currency had impacted the base for calculating the consumer price index. However, renowned economist, John Robertson argued that, Zimbabwe’s official annual inflation rate was 230 percent in July.

Obstacles to disinflation

High rates of inflation can be assumed to increase the costs of adjusting the economy as such inflation makes it more difficult to establish and observe new relative prices. This delays the transfer of resources into the expanding sectors of the economy. The situation is worsened if state owned firms and credit institutions are allowed to operate without binding budget constraints. An additional negative factor is if political pressure groups succeed in getting compensation for loss of income and higher prices are caused by changes in relative prices. Many adjustment programs have been terminated, or substantially reduced, due to the economic and political instability caused by high inflation. In August, a series of protest planned by the opposition over economic deterioration were prohibited by the police – beating activists and arresting opposition leaders.

The question is whether high and sustained inflation is unavoidable because the money supply process always passively accommodates changes in prices and exchange rates, or if the inflationary process can be controlled through monetary policy. To date, Zimbabwe can be regarded as an example, where the implementation of a relatively firm “structural reforms”, together with a tight credit policy, resulted in near hyper-inflation. Will stabilisation be achieved? The Southern African country launched its austerity measures under the Transitional Stabilization Program (TSP) in October 2018. Structural reforms are essentially measures that change the fabric of an economy, the institutional and regulatory framework in which businesses and people operate. They are designed to ensure the economy is fit and better able to realise its growth potential in a balanced way.

Finance Minister announced that the programme will run till December 2020, implementing cost cutting measures in reducing government expenditure and increasing government revenue in a bid to maintain fiscal balance. Economists believe that there is a strong connection between money and prices of goods. Moreso, a strong link exists between prices, money and foreign prices in domestic currency thus implying an interconnection between money stock and the real exchange rate during structural reforms.

Zimbabwe’s economic policies since 1980

Zimbabwe has a long history of structural adjustment programs. In its 39 years of existence as an independent state, Zimbabwe has come up with several economic blueprints aimed at promoting sustainable, inclusive economic growth and poverty alleviation. Early years were marked by policies aimed at redressing colonial era imbalances by assimilating previously marginalized people into the mainstream economy. The country embarked on a programme of post-war reconstruction with the support of foreign donors. In general, the reconstruction was successful as the economy was re-capitalised and reintegrated into the world economy. Later on, the thrust was to wean off its citizens from too much dependence on government for survival with the economy moving from being tightly controlled to liberalisation. The new government faced the pressing challenge of reconstituting and realigning the inherited national policy making structures in line with the new socio-politico-economic dispensation that had set in.

Some programmes emphasised government control thus fixing exchange rates and interest rates.  In some instances, various measures for controlling prices were introduced, but they could not prevent prices from raising. With distorted factor and goods prices, the programmes were not sustainable. Zimbabwe experienced high inflation levels since 2000, culminating into hyperinflation. Annual inflation peaked at 231 million percent in July 2008 and in response, the government printed its highest denomination of $100-trillion. The multicurrency occasioned by the 2007/08 hyperinflation subsequently, succeeded in ushering price stability over the years became history in June 2019. Zimbabwe’s central bank abolished the use of multicurrency in an effort to curb black market currency trade and halt re-dollarization.

Subsequent to that, the government embarked on rebuilding and for the past 39 years it has been coming up with several economic reform programmes. To date, Zimbabwe’s economic performance has been mixed, the instability has been influenced by policy lapses, economic mismanagement, adverse weather conditions that affected agricultural output, high levels of foreign capital inflows at independence in 1980, redistributive fiscal policies that focused on increased government spending on health, education and other social welfare programmes within the framework of the economy.

The government has over the years put in place different economic policies however, the economy still remains fragile and most of its economic policies have failed due to lack of proper implementation and resource constraints. Consequently, current recovery programmes may not be sustainable without meaningful and deeper reforms being undertaken to sustain GDP growth and other crucial indicators. There is also need for necessary institutional framework for the success of Zimbabwean policies. Current economic challenges require policy makers to change their paradigms towards prudent economic management and eradicate social ills such as corruption and economic mismanagement while reengaging the world. Foreign exchange rate depreciation and real income are found to be important factors for explaining inflation.

Structural Reforms, Inflation and Development Strategy

The success of a structural reform program in terms of avoiding inflation depends critically on the credibility of the program. In order to enhance this, Zimbabwe’s 2019 monetary policy focused on efforts to contain the growth in money supply and anchor inflation. However, this is proving to be highly challenging given sustained foreign exchange shortages and upward price pressure resulting from adverse weather conditions – drought and the impact of Cyclone Idai. Less than three months, Zimbabwe’s exchange rate regime hangs in flux, with authorities seeking to ban the use of foreign currency transactions, claiming that the new ZimDollar notes and coins will be introduced soon. Policymaking remains inconsistency as the establishment of a viable exchange rate regime remain depended on the build-up of adequate international reserves and macroeconomic stability – factors that are unlikely to be achieved over the coming quarters.

Again, the economy is currently decimated by smuggling, corruption and economic mismanagement, leaving it with little productive capacity, low exports, unable to access capital markets and largely bereft of foreign investment. Despite the fact that the strong US$ stifled the nation’s competitiveness, Zimbabwe’s external sector position has remained considerably under pressure on account of deep-seated structural challenges of fiscal deficit, limited access to foreign finance, debt overhang and limited supply of petroleum. Thus, the outlook is clouded by the ongoing drought, energy crisis and heightened debt vulnerabilities in an uncertain environment. Absent significant policy adjustments and lack of key reforms, growth is likely to remain subdued over the medium term due to policy slippage.

Inflation uncertainty and expectations.

Inflation drives inflation uncertainty and vice versa. The level of inflation, underpinned by its drivers, is seen as one of the most important indicators of general economic performance with implication on almost all sectors of an economy independent of the level of development or geography. There is wide consensus among economists and policymakers that ensuring stability in the general price is vital to the health of the economy and welfare of citizens. It is therefore no secret that economic managers all over the world face an arduous task of ensuring that inflation is stable and within growth-enhancing limits.

Often, high and unanticipated inflation rates tend to drag along with it a signal of price uncertainty to both policymakers and all other economic agents. The government’s acceptance of higher inflation rate would most likely drive expectations in such a manner to induce the general price level rising more rapidly and less steadily. It therefore follows from a generally believed economic prognosis that expectations are formed by economic agents about volatility and future inflation trends matter for current inflation. That is, high inflation leads to pronounced uncertainty.

Zimbabwe, similar to other Sub-Saharan African countries, has had often very high and volatile rates of inflation. Various reasons have been assigned for this trend notable among which include high public expenditure, excessive money supply growth, rapid depreciation of the domestic currency against major trading partners’, external shocks, drought and low agricultural productivity. Official statistics have often revealed high volatility in inflation especially in periods of high inflation and during the political-business cycle periods (that is, elections) even though in recent times the rates have generally been low and sometimes even in single digits compared to historical trends.

Zimbabwe’s chronic high inflation rates and accompanying price volatility over the past four months has stifled economic progress with the business community often entangled in a climate of high uncertainty. Most decisions regarding plant size expansion, investment and employment are either delayed or put on hold indefinitely. Could inflation targeting be the solution? An analysis of the entire distribution of either inflation or inflation uncertainty series and its implication for monetary policy conduct could be important given that it could potentially inform policy-makers on specifically where along the inflation distribution to set its target. Monetary authorities therefore, may consider an inflation targeting policy in order to reduce inflation uncertainty and its negative effect on inflation and economic growth in the medium-to-long term.

As the Central Bank seeks to consolidate the relative macroeconomic gains made since implementation of TSP.  Upside risks have been heightened on the basis of high domestic interest rates, low aggregate demand, recurrent energy crisis and negative business expectations. Thus efforts should be made taking into consideration all available information on relevant policy variables that drives down inflation uncertainty in Zimbabwe in order to keep rates of inflation within reasonable growth-enhancing ranges. This would improve the general macroeconomic outlook and health of the economy as expectations and speculative activities are effectively managed.

Reserve Bank of Zimbabwe will be announcing the midterm monetary policy statement in the near future, thus, monetary policy conduct by the Central Bank should aim at firmly anchoring inflation expectations to reduce persistence in the medium-to-long-term. To achieve this, the bank must further commit itself to greater transparency by improving its communications strategy and accountability to give the current monetary policy framework more credibility. To tame inflation within growth-enhancing limits, policy tightening through complementary mix of monetary and fiscal policies is recommended. In particular, prudent fiscal management through controlled public expenditure beyond an optimal threshold must be vigorously pursued. Macroeconomic policies aimed at stabilizing the exchange rate against rapid depreciation are also critical to achieving moderate inflation rates to boost growth. 

Given current economic conditions, government should avoid an expansive fiscal policy – large wages and housing allowances increases for civil servants that will result in raising inflation. However, controlling the monetary base is not sufficient if credit expansion turns out to be highly elastic with respect to price increases. As Zimbabwe public hospital doctors withdrew their services over poor wages, leaving Finance Minister in a dilemma –thus, political and economic realities at odds, leaving tough policy choices for Zimbabwe’s government.

Conclusion

Inflationary process is a critical aspect of structural adjustment programs however; many programs are terminated because of the destabilising effects of high inflation. Money supply is a key process during the implementation of an economic structural reform. In most cases, economic structural reforms increase money supply and cause inflation, but if the money process is not allowed to accommodate historical price increases, a tight monetary policy will contribute to reduce inflation and stabilise prices after some period. Zimbabwe, from falling prices to triple-digit inflation in less than three years. Indeed, numbers don’t lie. People do!

Samuel Mapuranga writes in his own personal capacity. The views expressed in this article are those of the author and do not necessarily represent any organisation. Feedback: Email – smapuranga15@gmail.com; or Twitter: @Sa_miiM