Tipo y Nivel de Investigación Por su finalidad: Aplicada

As noted earlier, there is no real consensus on the causes of inflation, predominantly because the phenomenon is a result of several factors that either act together or in isolation to cause a

fall or rise in the cost of living. In most economics literature, though, the causes are grouped in three main categories: cost–push inflation, demand–pull inflation and monetary inflation. Cost–push inflation, which is regarded as the supply side inflation (Beardshow, 1992), is caused by a rise the production input costs. Parkin, Powell and Matthews (1997) consider two main sources of this increase in production costs, which are an increase in money wage rate and in the price of raw materials. An increase in wage rate can be induced by the bargaining power of employees due to either the presence of powerful unions or the shortage of appropriate labour force in the job market. The Zimbabwe Congress of Trade Unions (ZCTU), which is a powerful labour organisation, usually negotiates industry salaries on behalf of workers, linking these to the inflation rate. The challenge for employers in a union–driven market is that wages and salaries are negotiated nationwide with little consideration for individual company or regional situations Thus the only logical reaction of the firm will be to pass the costs to the supply chain. The effect of producers passing on costs by factoring them into the production cost is that the producers’ prices increase, especially as the majority of industries in Zimbabwe are mark-up driven. The situation is made worse by the fact that the consumer market in the country is a suppliers’ market. Therefore it is more sensitive to supply than demand influences, and the prices of goods tend to go up with the rising cost of production.

To control inflation of this magnitude is contentious, in that governments will have to introduce unpopular policies like wage freeze and price controls, steps which could face resistance from unions and businesses alike. In August 2007, however, the Zimbabwean government did bite the bullet and announce that wages be frozen and that any increase would

need government approval. The result of this gazetted statutory bravery by the state was a call for a nationwide strike by the trade unions on 19th and 20th September 2007. This did not receive full worker participation, but it does illustrate the risks associated with such policies. The salary freeze was a last ditch attempt to avoid further collapse and a deepening economic crisis induced by an unpopular government whose policies also included a tripartite consultative forum. In this forum, made up of the state, the trade unions and business, the government had tried unsuccessfully to negotiate a voluntary freeze, cap or limit to salary increases as well as a commodity price freeze. The commodity price freeze was also unsuccessful, as it led to widespread chronic shortages of food and basic commodities. This prompted the government to reverse its policy, since pegged prices meant producers could not even meet their production costs, making it impossible for them to manufacture.

The other cost–push inflation is due to a rise in raw material prices, which has the same effect as that of wage rate increase, though it could be caused by either internal drivers or external forces such as the increase of price of an imported good which forces may be beyond the control of the state. While the official exchange rate in Zimbabwe was Z$250.00 per US$1.00 in January 2007, rationing of foreign currency meant that producers had to look for the currency from the black market at over Z$1,500.00 to the US$1.00. The effect of this was expensive raw materials for the production of goods, which ultimately resulted in a rise in prices and eventually inflation. Raw material shortages were also worsened by the disruptions in the farming sector, where the Government evicted commercial farmers, replacing them with subsistence ones. Commercial farmers produced and supplied agricultural products such as maize, ground nuts, milk and beef to the urban population at local prices. However, after the

disruptions, some of the basic commodities had to be imported since most of the resettled farmers produced for their own consumption. This is in addition to the fact that Zimbabwe has always been a net importer of goods and services; thus the economy has always been sensitive to exchange movements.

Granger Causality Tests are used in this study to determine the effect of the exchange rate on the inflation rate in Zimbabwe from February 2002 to January 2007, and the results are presented below in Table 4.12. As noted above, the effect of the exchange rate on inflation was made worse by the displacement of commercial farmers who also produced cotton and tobacco, which were leading earners of foreign currency in the agrarian Zimbabwe economy.

Null Hypothesis: Obs. F-Statistic Probability EXC does not Granger Cause CPI 60 116.304 5.7E-26 CPI does not Granger Cause EXC 6.95816 5.6E-05

Table 4.12: Granger causality for inflation and exchange rate between 2002 and 2007

Table 4.12 shows that there was a statistically significant bilateral causality between inflation and the exchange rate over the period, since the calculated F-statistics are significant. These results indicate that between 2002 and 2007 the exchange rate in Zimbabwe provided useful information about the movement of the inflation rate, while the inflation rate also contained useful information about the exchange rate. As noted earlier, the fall in agricultural productivity led to a reduction in exports, thereby inducing a balance of trade deficit causing more foreign currency shortages and a fall in the Zimbabwean dollar. The fall in the dollar meant imports became expensive, thus pushing up production costs and inflation as a result.

In addition to cost–push factors, demand–pull inflation influences are also an inflation driver, and are a result of excess demand of goods and services while the economy is at full employment. Excess demand in this case refers to aggregate demand, which is made up of the total of consumer goods expenditure, government spending, investment expenditure and exports, less imports. Parkin, Powell and Matthews (1997) state that this excess aggregate demand could be due to an increase in the money supply, increase in government purchases or an increase in the price level or real GDP in the rest of the world. This cause of inflation is the subject of repressed form of unofficial inflation, which was noted by Munoz (2006) in Zimbabwe, where consumers end up with lots of cash in their hands while products for its disposal are not readily available. Another dimension of demand–pull inflation in Zimbabwe is the occurrence of continuous demand inflation, which Griffiths and Wall (2001) say is a sustained upward movement in the price levels due to a maintained growth in aggregate demand. Government price controls in Zimbabwe induced widespread shortages and a thriving black market, thus demand for goods at official market prices resulted in continuous demand for such goods by consumers who bought for use, consumption or storage. Government expenditure is also one of the factors leading to demand–pull inflation, especially since government purchases are huge and may create excess demand, as ordinary consumers compete for the same goods. In the case of Zimbabwe, government expenditure rose owing to the purchase of agricultural goods as the demand to support newly resettled farmers became a priority.

Despite the above influences of either a cost–push or demand–pull nature, Beardshow (1992) points out that monetarists’ thinking is that inflation is entirely caused by a too-rapid increase

in the money stock and nothing else. While the influence of monetary shocks acts as a catalyst for either cost–push or demand–pull inflation, the occurrence of push and pull factors in Zimbabwe explained above shows that they have been independently inducing inflation. Supply of money, which can also come in the form of an increase in interest rates, avails more disposable income to consumers and also becomes a catalyst for government expenditure resulting in excess demand and hence a demand–pull inflationary pressure.

Null Hypothesis: Obs F-Statistic Probability M1 does not Granger Cause CPI 60 1.16016 0.34213 CPI does not Granger Cause M1 2.08397 0.08329

Table 4.13: Granger causality for inflation and money supply between 1997 and 2002

However, there is no evidence that money supply (M1) caused inflation between 1997 and 2002 in Zimbabwe, as the Granger Causality test results show in Table 4.13 above. In fact, there is evidence that inflation provided useful information about movements in money supply rather than vice versa making this a one–way direction causality. This assertion is at 10% level of significance, which is an acceptable level of probability. The monetarist view, however, is not totally dismissed during this period, as interest rates did Granger cause inflation as demonstrated in Table 4.14 below.

Null Hypothesis: Obs F-Statistic Probability INT does not Granger Cause CPI 60 2.99684 0.01942 CPI does not Granger Cause INT 0.98125 0.43872

Table 4.14: Granger causality for inflation and interest rate between 1997 and 2002

Interest rates between 1997 and 2002 Granger caused inflation and thus provided useful information about the movements of inflation during the period. The results also show that inflation did not cause movement in interest rates since the probability is 0.44, which is not

within the acceptable levels of significance. Interest rates also provided useful information about inflation between 2002 and 2007, as shown in Table 4.15 below. This is also one– direction causality from interest rates to inflation. Statistically, inflation did not cause movement in interest rates in Zimbabwe, and this is consistent with economic theory, which shows interest rates providing useful information on inflation.

Null Hypothesis: Obs F-Statistic Probability INT does not Granger Cause CPI 60 37.8841 1.0E-15 CPI does not Granger Cause INT 1.43587

0.22818

Table 4.15: Granger causality for inflation and the interest rate between 2002 and 2007

The above submission should be considered, however, in the context of the different approaches used to address inflation. If government policy is proactive, then Table 4.15 obtains but if the policies are reactive then inflation would Granger cause interest rates as the government uses interest rates to address inflation challenges. In Zimbabwe, interest rates post–2002 were fixed as the government sought to arrest its own expenditure. Thus its use of interest rates to address inflation challenges was limited.

While money supply did not cause inflation during the 1997 and 2002 period, the situation changed in the five years leading up to January 2007. In fact that money supply (M3) in Zimbabwe rose from 99.5% in January 2002 to 1,638.4% in January 2007, which increase, when compared to the inflation increase of 116.7% to 1,593.6% in the same period, shows the influence of this variable to inflation in the country. However, this rise could be a result of inflation increasing money supply since such a large increase in the inflation rate would have to be supported by a substantial increase in money supply lest cash shortages surface. Table 4.16

below shows that money supply and inflation have a bilateral causality over this period, supporting the above submission.

Null Hypothesis: Obs F-Statistic Probability M1 does not Granger Cause CPI 60 14.0491 1.6E-08 CPI does not Granger Cause M1 13.5302

2.7E-08

Table 4.16: Granger causality for inflation and money supply between 2002 and 2007

The results show a statistically significant two-way directional causality between inflation and money supply at 5% level of significance. This is consistent with the findings of Kovanen (2004), who also noted that money in circulation provides strong information about movements of inflation in Zimbabwe, compared to other monetary aggregates like interest rates, which were predominantly fixed between 2002 and 2007.

4.7 Conclusion

Inflation in Zimbabwe has increased from 3.22% in June 1988 to 1,593.6% by January 2007, an increase well over 1,500%, and research on inflation in Africa would therefore be incomplete without considering the world’s highest inflation rate, which the World Bank correctly projected could reach 100,000% within a year from May 2007. At the end of 2008, the annual inflation rate had risen to 2.4 million percent. The cause of this surge in inflation was a cocktail of factors including the critical shortage of foreign currency, excess demand caused by shortages and price controls, strong trade unions, money supply and inadequate policies to arrest the hyper inflation. Using Granger Causality tests, there is evidence of bilateral causality between inflation and money supply as well as the exchange rate in Zimbabwe between 2002 and 2007. However, the causality runs one way from interest rate to

inflation during the same period. Five years prior to 2002 causality was one way only, from interest rates to inflation and inflation to money supply, and there was no bilateral nor any causality found between the exchange rate and inflation. Between 1997 and 2002, currency rationing had not yet been rampant in the country, although a fixed currency regime started in December 1997, explaining the causality differences between the exchange rate and inflation for the two periods.

Although the inflation rate in Zimbabwe has been in hyper-state, the announced official figures have been understated owing to the existence of hidden inflation. This chapter explored why there is credence in reports that inflation in Zimbabwe as officially announced is understated, hence contributing to the current debate on inflation in Africa, and Zimbabwe in particular. The issue of understated inflation figures was looked at from the perspective of weights, recalculating the index using monthly increases and simulated weights, an approach which Nuti (1986) suggests is one of the methods of unearthing hidden inflation. The evidence presented in this chapter shows that annual inflation in Zimbabwe was understated by over 35% by June 2007. The need for the recalculation of weights in Zimbabwe therefore cannot be over emphasised, as the current weights fall short of the practical consumer basket. These findings are new from the hidden inflation angle of unveiling unofficial inflation, and they also support evidence already established by a repressed inflation approach to unofficial inflation carried out by Munoz in Zimbabwe in 2006. Munoz (2006) used a repressed inflation approach to show that inflation in Zimbabwe is understated, but since this approach is not exhaustive, the method used in this study provides further proof of the claims which Munoz put forward on the inflation rate in Zimbabwe. The presence of hidden inflation, however, could be higher

than this evidence suggests if black market prices and substitute products are taken into consideration.

Apart from the evidence of hidden inflation in Zimbabwe, there is also concern about the accuracy of inflation figures in other African countries. In particular, the statistically higher increases in food inflation, the largest component of the inflation basket, are worrying especially since most countries in the continent only change their weights after five years, and in some cases over ten years. The effect of this is a household expenditure basket which is outdated, resulting in an incorrect inflation rate, thus suggesting the existence of hidden inflation. Another finding from the empirical work in this study is the significant positive relationship between changes in poverty and the food weights within a consumer basket. Poverty in this case was measured in terms of the International Poverty Line for comparison, which measure looks at the percentage of people within a country living on less than US$2 per day. This finding reinforces the need for countries to carry out consumer consumption surveys more often when people’s living standards, as measured by the consumer price index, are falling.

The importance of obtaining correct inflation rate figures is multidimensional, starting from the rate figures being used by workers in the country to negotiate salary increases to businesses projecting future growth and governments preparing adequate policies to tackle economic challenges. The understatement of figures will therefore deprive the workers of an appropriate or real salary increase. Their income will be eroded over time, which has notoriously happened to the Zimbabwe labour market in the wake of the current hyperinflation. Businesses also fail

to meet targets that cover their costs adequately, and even when they do the realised profit after inflation adjustment becomes an investor’s trap, as it provides misleading information about the real situation regarding the profitability of the venture. From a policy viewpoint, correct inflation figures help arrest rampant budget deficiency which is a worrying element of high inflation countries, especially those with understated figures. For a government, there might also be a call for the knowledge of correct figures to ensure that mechanisms that are meant to correct inflation surge are adequate to meet the expectations of the economy, and this can be best done by the production of correct and up–to–date inflation figures.