Download Zimbabwe Monetary Policy 1998-2012: From Hyperinflation to

Zimbabwe Monetary Policy 1998-2012:
From Hyperinflation to Dollarization1
By Dr. Mark Ellyne and
Michael Daly2
Abstract
Zimbabwe’s 2008 hyperinflation is said to be the second highest in recorded history, and
provides an interesting case study of policy failure. We explore possible motivating
factors behind the hyperinflation to understand why it happened and persisted for so
long, and who benefited from it.
The paper examines the exchange rate–inflation spiral and explains how a large parallel
foreign exchange market generated high profits for some, especially state-owned
enterprises and those with insider connections who could arbitrage the dual exchange
rate system. The paper explores the determination of the exchange rate, and tests the
purchasing power parity hypothesis. It finds that PPP held for the official exchange rate
but not the parallel exchange rate, providing evidence of structural change in the
economy. It examines the causality among money, prices and the exchange rate using a
vector error correction model to better understand the impact of monetary policy. In
examining the hyperinflation, this paper uses the “Impossible Trinity Hypothesis” to
explore the possibility that Zimbabwe’s policy-makers may have been trying set both the
exchange rate and monetary policy.
The paper also examines the “dollarization” exit strategy and post-2008 economic
policies. It argues that the choice of using the US dollar as the main currency of the
dollarized Zimbabwe was not optimal based on optimal currency area theory.
Additionally, subsequent policies to influence domestic liquidity and control investment
have created new and serious problems for the country’s economy.
This case study of Zimbabwe’s hyperinflation and subsequent dollarization provides
lessons for other developing economies about conducting monetary policy and the
impact of full dollarization.
Keywords: Hyperinflation, Zimbabwe, Dollarization, Impossible Trinity, Capital Controls, Monetary
Policy.
JEL Classification: E42, F31, E5
1
This paper is forthcoming in Economic Management under Hyperinflationary Environment: Lessons from
Zimbabwe, Oxford University Press.
2 Mark Ellyne ([email protected]) is Adjunct Associate Professor of Economics at University of Cape Town,
and Michael Daly ([email protected]) is a post-graduate student in the School of Economics.
2
INTRODUCTION
Much work has been done to show that hyperinflation is a government-created and sustained policy
failure that cannot occur without monetary accommodation (Sicklos, 1995). We try to further
examine the factors behind the Zimbabwe event and ask at what level policy-makers considered
what they were doing: (1) Were government leaders ignorant of the impact of their policies? (2)
Were government policy-makers trying to pursue an alternative strategy but inept with the
implementation? or (3) Were government leaders knowingly transferring purchasing power from the
private sector to the public sector? The goal is to better understand how such policy failures occur,
and to learn lessons so that similar disasters do not occur in the future in Zimbabwe or elsewhere.
This paper explores the dual exchange rate markets that existed during the 2000 to 2008 period to
understand how some benefited from the inflation-depreciation. We examine how the parallel and
official exchange rates adjusted during this period and test a monetary model of exchange rate
determination, using cointegration analysis, to determine identify whether purchasing power parity
held during this period..
We explore the possibility that the government was pursuing an alternative monetary and exchange
rate policy prior to 2009, following a Chinese or former Soviet Union (FSU) foreign exchange market
model. The authors use the “Impossible Trinity Hypothesis” (ITH) as a framework to explain the logic
of this model and why it was not optimal for the country.
Alternatively, the poor economic decisions taken by Zimbabwean policy-makers in the lead up to the
economic crisis may have been politically motivated. In this case, an understanding of the potential
winners and losers of this inflationary policy provides further understanding of the phenomenon?
To conclude, we examine the hyperinflation exit strategy in terms of optimal currency area theory
and conclude that official multicurrency dollarization, dominated by the US dollar, may not have
been the optimal long-run policy choice and that moving forward, a regional strategy should be
considered.
Finally, we consider the current economic policy challenges facing the country under dollarization,
including: creating a balance of payments surplus; potential dangers of trying to control monetary
policy, and the strategy to raise investment. We find potential grave crises lurking in all of these
areas. Zimbabwean policy-makers also seem divided on the way forward. Economic policies appear
to reflect short-term political goals as opposed to more rapid improvement of economic welfare;
although this could also represent some social time-preference. Based on these and past policies, we
believe that government has too heavily relied upon monetary policy to support its political agenda,
sometimes at the expense of the general economic welfare.
HYPERINFLATION IN HISTORICAL PERSPECTIVE
Inflation camouflages income redistribution and should be understood as a socio-political battle as
well as an economic issue, because one person’s costs are another’s income. By examining the
source of inflation and the winners and losers in the inflation process, one can begin to understand
this economic phenomenon in social terms. Hyperinflation is often associated with changing political
conditions, war, social unrest, or political mismanagement. It is also true that hyperinflation must be
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accommodated by printing money and hence the government always bears some role for creating it
as well as the responsibility for resolving it. Inflation may be the process used to re-distribute real
income shares in a hidden manner. Often it is a battle between capital and labour or between the
public and private sectors for shares of the national income. Typically, increasing inflation is
generally linked with the depreciation of the exchange rate which sustains an inflation-depreciation
spiral. Thus, ending hyperinflation is usually linked with the stabilization of the exchange rate.
For the purposes of this paper, we focus on the period beginning in 1998 as the starting point for the
inflationary period that lasted until end-2008. Prior to this, Zimbabwe had been following an IMF
structural adjustment program. The break with the Fund was mainly due to an excessive government
deficit linked to payments to the “war veterans” (of Zimbabwe’s war for independence). Following
an inconclusive IMF mission at end-1997, there was a 70 percent depreciation in the Zimbabwe
dollar exchange rate in 1998 and an outright break with policies agreed with the Fund. RBZ quasifiscal expenditure began after that, and the end-year annual inflation rose from 20 percent at end1997 to over 50 percent at end-1999, and accelerated to an estimated 66,200 percent at end-2007.
In Zimbabwe’s case, the hyperinflation arose from rapid growth in central bank reserve money, not
just by lending to the government but by excessive central bank lending to state-owned enterprises
and other private sector entities. Between 1990 and 1997, the fiscal deficit averaged 6 percent of
GDP, and this expanded to 20 percent by 2000 before being inflated away. During the 1998-2008
period, direct lending to the economy by the Reserve Bank of Zimbabwe (RBZ) acted as a means to
avoiding an even more rapidly rising fiscal deficit. This hidden quasi-fiscal activity of the RBZ was
largely directed to State Owned Enterprises (SOEs) in a surreptitious manner. This was a disguised
fiscal deficit financed by printing high-powered money.
According to Hanke and Krus (2012), the Zimbabwe hyperinflation ranks as the second highest in
history, surpassed only by the 1946 hyperinflation in Hungary (Table 1). They identify these
hyperinflations following the definition provided by Cagan (1956), which is when the price-level
increases by at least 50% per month. Similarly, if the inflation rate drops below 50% and remains
below 50% for at least one year, the episode of hyperinflation is said to have ended. Based on this
definition, Hanke and Krus identified just 29 case of hyperinflation in history, the most recent was
Bulgaria in 1997. Of course, for such high levels of inflation, reliable measurement of price data is
problematic.
Hyperinflation only rose to prominence in the early half of the twentieth century when it ravaged
the economies of a number of European nations post-World War 1. This period of European
economic and political instability led to the famous German hyperinflation in 1922, where inflation
rates peaked at 29,500% per month (Table 1). While Germany’s peak inflation rate was drastically
lower than more recent hyperinflations, it was the most severe one experienced at the time. It led to
rapid depreciation of the Reichsmark and a shortage of cash, which prompted the central bank to
increase currency in circulation in order to facilitate transactions at higher prices (Heifferich, 1927).
Analysts have since pointed out that the German hyperinflation was as much a socio-political as an
economic phenomenon. The burden of punitive war reparations imposed at Versailles limited the
government’s room for manoeuvre in economic policy. Modern literature takes the more monetarist
view that the excessive creation of currency drives inflation. In Germany’s case, the increase in the
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supply of money was accomplished through the increased discounting of commercial and
government bills by the Reichsbank (Burdekin & Burkett).
Table 1. Ten Highest Recorded Hyperinflations
Start date
End-date
Maximum
Monthly Rate--%
Hungary
Aug 1945
Zimbabwe
Mar 2007
Yugoslavia
Apr 1992
Republika Srpska
Apr 1992
Germany
Aug 1922
Greece
May 1941
China
Oct 1947
Danzig
Aug 1922
Armenia
Oct 1993
Turkmenistan
Jan 1992
Source: Hanke and Krus (2012).
Jul 1946
Nov 2008
Jan 1994
Jan 1994
Dec 1923
Dec 1945
May 1945
Oct 1923
Dec 1994
Nov 1993
4.19 x 1016
7.96 x 1010
3.13 x 108
2.97 x 108
29,500
13,800
5,070
2,440
438
429
Country
The aftermath of World War 2 brought with it a new batch of hyperinflationary episodes—Hungary,
Greece, Taiwan, Philippians and China. Of these Hungary is the most noted, and is the most severe
hyperinflation on record. During this episode Hungary experienced a peak monthly rate of 4.19x1016
percent and an overall price increase over the 13 month period of 3x1025. Hungary’s inflation was
unique. Bomberger and Makinen (1980) note, that of all the countries that experienced
hyperinflation after World War 1, only Hungary experienced a second hyperinflationary period after
World War 2. Additionally, the looting by the Soviet and German forces during World War 2 left the
country with a greatly depleted level of capital stock, and output of between 40 and 50 percent of
the pre-war level (Bomberger & Makinen). Reparations after the war accounted for 25-50 percent of
the monthly expenditures of the Hungarian government. Central Bank officials repeatedly warned
the Allied Control Commission that the process of discounting treasury bills to finance such a large
deficit would inevitably lead to a repetition of their earlier hyperinflation. The Soviets who
dominated this commission disregarded these warning, leading some to believe that the
hyperinflation was encouraged to achieve a political objective—the destruction of the middle class
(Bomberger & Makinen).
The next wave of hyperinflationary episodes occurred in the 1980’s in the Latin American countries
of Peru, Nicaragua, Argentina, Bolivia and Brazil. Bolivia is interesting as it was the first instance of
hyperinflation in over 30 years, excluding Chile which experienced a very brief hyperinflation in
October of 1973. The Bolivian hyperinflation is particularly notable as it is one of the only
hyperinflations that did not result from war or revolution. The proximate cause of the hyperinflation
was Bolivia’s loss of international creditworthiness in the early 1980’s. During the period of 19751981 the Bolivian government relied heavily on foreign borrowing to finance public expenditures
(Bernholtz, 1988). The combination of increasing international debt, a poor tax system,
macroeconomic mismanagement, and poor export performance prevented the Bolivian government
from procuring further international loans. When foreign capital inflows dried up in early 1982, the
government lacked the political support to raise taxes, so it substituted domestic credit expansion
for foreign capital flows as the means to finance the government (Sachs, 1987). The rapid expansion
of the money supply then set off the inflationary process.
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In the early 1990’s, the dissolution of the Soviet Union resulted in political and social turmoil setting
off a period of hyperinflations in former Soviet states. The most unique of these was the Yugoslav
hyperinflation, which reached 313 million percent on a monthly basis in January 1994 and was one
of the longest recorded periods of hyperinflation. That hyperinflation was closely associated with the
disintegration of the former Yugoslavia, the ensuing loss of monetary and fiscal control, wars in the
region, and a comprehensive international economic embargo imposed on the country (Bogetic &
Petrovic). As inflation increased, output halved and the fiscal deficit rose to 28 percent of GDP
(Bogetic & Petrovic). In this respect the Yugoslav hyperinflation is similar to that of the Hungarian
hyperinflation of 1945-1946, where a drop in output of between 40 and 50% was experienced. The
dramatic increase in the fiscal deficit was of similar dynamics to those in the early hyperinflations of
Germany and Austria. A significant increase in seignorage preceded the hyperinflation and was used
to finance the growing fiscal deficit. Towards the end of the hyperinflation, the economy
experienced almost complete unofficial dollarization to the Deutsche Mark, which was openly
traded at universally known daily black market exchange rates–very similar to the story that
unfolded in Zimbabwe almost 20 years later.
The 1990’s also saw two African hyperinflations: the Congo (Brazzaville) and the Democratic
Republic of Congo (DRC). As with a number of past hyperinflations, the root of the DRC’s
hyperinflation was primarily political—the collapse of conventional government was coupled with an
explosion in government spending and falling revenue collection (Beaugrand, 1997). This
government spending was financed almost entirely by printing currency. In addition, the political
crisis led to a decrease in external trade and output. In the turmoil that resulted from changing
political dynamics in the country in 1990, the authorities granted government employees large wage
increases that nearly trebled the wage bill in order to thwart growing discontent (Beaugrand, 1997).
At the same time government revenue was falling, largely due to a decrease in mining taxes and
dividends.
The Zimbabwe hyperinflation has many similarities to past hyperinflations, including some elements
of war and fiscal failures. As with the hyperinflations of Hungary and the Democratic Republic of
Congo, the episode in Zimbabwe was preceded by a marked decline in real GDP. Between 1998 and
2008, real GDP in constant (1990) Zimbabwe dollars declined by an estimated 55% from Z$ 10.4
billion to 4.7 billion (Figure 1). Moreover, it may be unique in that it happened during a period of low
international inflation and reflected mainly domestic issues.
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Figure 1. Zimbabwe: Real GDP
(in constant 1990 Zimbabwe dollars)
Source: RBZ’s GDP for 1990 indexed by the real GDP growth rate recorded by the
IMF’s WEO database.
BACKGROUND TO THE ZIMBABWE HYPERINFLATION
As noted above, hyperinflation is usually a socio-political occurrence as much as a monetary one. In
this respect, we explore several key socio-political events that may have contributed to Zimbabwe’s
hyperinflation, including: (i) gratuities paid to the war veterans, (ii)the government’s participation in
a regional war, (iii) the government’s push for land reform, and (iv) the new political challenge to
President Mugabe’s ZANU-PF party.
Appeasing The War Veterans
In August 1997, Mugabe conceded gratuities and monthly pensions to the politically powerful group
of “war veterans.” The gratuities alone cost the government more than twice the total government
spending on land reform since 1980. (Selby) This dramatic increase in government expenditure had
serious negative consequences for the country’s budget position, which was subsequently
exacerbated by its participation in the Congo war the following year.
The Congo War
The Zimbabwean government’s decision to enter into the Second Congo War in 1998 on the side of
Laurent Kabila started Zimbabwe on “the road to economic ruin” (Noko, 2011). The government had
not budgeted for the war, it turned out to be more expensive than originally anticipated, and the
President could not raise taxes to pay for it. Zimbabwe’s decision to deploy troops to the DRC
conflict was one of the most troublesome for its citizens given that there was no clear rationale for
Zimbabwe to become involved (Maclean, 2002). One commonly cited explanation was that the illicit
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mineral trade in the DRC offered lucrative possibilities for rewarding those loyal to ZANU (Maclean,
2002). Additionally, it could ensure the allegiance of the strategically important military.
By August 2000, Maclean (2002) estimated that the government had spent more than 10 billion
Zimbabwean dollars (200 million US dollars) in two years in the conflict. This was expenditure the
government could not afford, as real GDP was in decline. In such circumstances, it is understandable
that the government turned to printing money or RBZ financing as an alternative to real adjustment
policies.
Land Reform
The structural inequality of land ownership between white and black Zimbabweans was a social and
political sore point, which ZANU-PF argued would inevitably lead to economic and political
instability. It was frequently cited by Mugabe as a major problem, although little was done to rectify
the problem for two decades after independence. ZANU-PF portrayed the land redistribution as a
basis for economic empowerment, growth and development (Masunungure & Badza, 2010).
Until the land expropriation programme began in 2000, the land reform had been handled under the
premise of “willing buyer—willing seller.” Beginning in 1999/2000, the government-supported war
veterans invaded and forcibly took control of nearly all the 4500 white-owned commercial farms in
Zimbabwe (Noko, 2011). This provided a convenient, low-cost strategy for land redistribution. Under
the fast-track land reform programme many of the commercial farms were simply handed over to
important ZANU-PF members, but some were broken up and given to new farmers.
The land reform process focussed on the numbers of those resettled or needing resettlement, both
in the 1980’s and in the 2000’s, obscuring other vital dimensions such as infrastructure and service
support to make reform sustainable (Sachikonye, 2003). The new farmers had limited access to
financing as banks refused to recognise the transfer of ownership under Zimbabwe’s expropriation
programme. Some estimate that agricultural output may have declined by as much declined by
85.7% between 2002 and 2009, and Zimbabwe shifted from being a net food exporter to a net food
importer (Noko, 2011). This decline was attributable to a combination of the land reform, unsuitable
macroeconomic policies, increasing levels of inflation and a weakening financial system.
Notwithstanding this, quite a number of small-scale tobacco farmers have been successful at earning
a living and keeping the tobacco industry alive.
Noko (2011) cites the financial support for the land redistribution programme as one source of
inflationary policies. Under the “Farm Mechanization Program,” and other similar programs, the
government and the RBZ offered free or concessional financing to new farmers. In mid-2008 the
government authorized the RBZ to print “Special Agro-Cheque” notes to finance farmers. These
programmes added to the inflationary quasi-fiscal activities of the RZB, which were a key
contributing factor to the rampant growth of inflation.
While no complete costing has been done to determine the full cost of Zimbabwe’s land reform
programme, conservative figures from the Commercial Farmers’ Union of Zimbabwe (CFU) estimate
that the destabilization of the agricultural sector between 2000 and 2011 has cost the Zimbabwean
economy US$33 billion (Theron, 2010).Subsequent sanctions imposed by the United States of
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America and a number of European countries along with IMF restrictions further dampened hopes
of recovery..
Political Challenge
During the first two decade after independence, President Mugabe had been in the comfortable
position of being able to manage the Zimbabwean economy with relatively little political opposition.
During the 1980s, there was opposition from Joshua Nkomo’s ZAPU supporters in the south of the
country. The first real domestic rebellion against Mugabe might be considered the civil unrest of the
‘war veterans,’ who were given a large unbudgeted gratuity in 1997 that destabilized the Structural
Adjustment Program with the IMF at the time. However; with the formation of the first major
opposition party in 1999—the Movement for Democratic Change (MDC)3 under the leadership of
Morgan Tsvangirai—Mugabe faced a tangible political challenge for the first time. This challenge to
ZANU-PF seemed to lead to the use government institutions and policies to maintain ZANU-PF’s
political power.
Nhvira (2012) notes that already in 1999 the government took the step to amend Section 9 of the
Bank of Zimbabwe Act, which had been in force since 1964, to remove the time limit for repayment
of loans advanced to the government. This opened the way for fiscal deficits that didn’t ever have to
be repaid and greatly damaged the well-being of the RBZ.
This growing threat from the opposition MDC and the increasing instability in the Zimbabwean
economy became more apparent after the 2000 election, which Mugabe only won narrowly by a
vote of 47.2% to 45.6% of the electorate (Lodge, Kadima and Pottie, 2002). As support for the MDC
grew following that election, so did the level of ZANU-PF patronage. Prudent fiscal and monetary
management slowly deteriorated.
Simple abuse of the government budget is difficult as fiscal spending is monitored by the Parliament
and the public. More sophisticated means of hiding politically-biased spending usually go through
SOEs, whose accounts are not open to the public and are more easily camouflaged. In Zimbabwe,
the SOEs represented a substantial share of the economy and covered institutions from the public
utilities to the Grain Marketing Board and various industrial corporations. The ruling party developed
a method for funding loss-making SOEs outside of the budget, by using direct loans from the central
bank, which was a hidden form of quasi-fiscal spending. Normally, such policies are not tolerated by
central banks.
A more positive interpretation of the RBZ’s conduct might say that it assumed the behaviour of a
development bank and tried to expand the supply side of the economy by supplying low interest
loans to selective productive sectors. Such a strategy of stimulating the economy through the
creation of high-powered money was a very risky strategy and not well-developed.
As prudent management of the money supply was relaxed, high inflation expectations became
entrenched. According to the RBZ balance sheet, the growth of its reserve money rose from around
60% per annum at end-1999 to about 180% at end-2002, and then to 400% at end 2003. The growth
in this “high powered money” appeared to come from a combination of direct credit to non3 MDC later split into two factions: MDC-T and MDC, although we refer to them jointly here as the MDC
opposition.
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government enterprises and the rediscounting of treasury bills. It is particularly notable that the net
foreign assets of the RBZ were negative by end-1997, implying that the central bank had no net
foreign reserves. In short, it appeared that the government (or the ruling party) used the RBZ to fund
and hide quasi-fiscal spending and drove the bank into bankruptcy.
It is noteworthy that the official beginning of hyperinflation began in March 2007, just 1 year before
the March 2008 election. In that election, it was widely believed that ZANU-PF had lost to MDC, but
would not yield power. The election results foreshadowed the peak of the hyperinflationary period
in November 2008, and again seemed to provide evidence that hyperinflation reflects a sociopolitical battle.
Winners and Losers from Inflation
Identifying the winners and losers from high inflation may help understand the motivation for
inflationary behaviour. Rising government spending first benefited civil servants receiving
government wages and pensions, like the military and war veterans. Secondly, government and
quasi-fiscal lending of the RBZ benefited the SOEs, which employed large numbers of people. As long
as they received their accelerating wage increases before others, they could benefit from
temporarily improved purchasing power, until eroded by the subsequent rise in inflation. In such a
situation, the government temporarily gains a greater share of domestic purchasing power, at the
expense of the private sector.
In the private sector, those agents who were involved in foreign trade or had access to foreign
exchange at the official rate did not suffer as much from the inflationary environment, as they could
protect their purchasing power by holding foreign exchange (Manyani, 2011). Those working solely
in the Zimbabwe-dollar economy had no way of protecting their saving except to buy real assets as
quickly as possible. The dual foreign exchange market (explained below) allowed many unprofitable
state enterprises, government officials and others with access to the official exchange rate to
prosper, off profits made through arbitrage with the parallel market exchange rate rather than
creating genuine added value. The high inflation environment hit the farming peasantry particularly
hard, as they had little access to foreign exchange at the official rate but pushed up the prices of
farm inputs (Manyani, 2011).
The dual foreign exchange markets created a zero-sum game for creating wealth. Given that the size
of GDP is basically fixed in the short run, creating large profits from short-term speculation without
adding to real productive output creates a zero-sum game, where others must be losing value. The
losers are inevitably the persons working only in the Zimbabwe-dollar sector, whose labour is being
purchased with a rapidly depreciating currency. The losers in this dual exchange rate inflationary
system were primarily the rural peasant workers and unskilled urban labourers who received
Zimbabwe-dollar wages and had no way to protect against their loss of purchasing power.
Direct profits could be made by those with links to the government or SOEs who were able to access
foreign exchange at the official rate and sell it (or use it) at the parallel rate, which allowed them to
generate rents or exploit value added through arbitrage. However, companies that needed imported
raw materials suffered for lack of foreign exchange and many saw their business collapse.
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Thus we conclude that public sector was the starting point for inflationary pressure, and those
involved in government or public enterprises may have received some benefit of being at the
beginning of the monetary and inflationary spiral. The subsequent inflation-devaluation spiral was
aggravated by the multiple exchange rate markets in existence, which encouraged profiteering by
those who could cross the walls separating them. Agents working in the foreign trade sector
probably fared better because they could protect themselves through hedging in foreign currency or
tradable goods. However, the real losers in this system were those agents that had no access to
foreign exchange but could only sell their labour for a currency that had a declining purchasing
power.
THE INFLATION-DEVALUATION SPIRAL
Zimbabwe had been following an IMF program during the mid-1990s, and we can compare
monetary policy by the growth of reserve money (Figure 2). Despite some period of deterioration
during 1997, monetary policy began to significantly break down in 1999, and seriously collapsed by
end-2001 when the annual growth in reserve money surpassed 100 percent; broad money followed
suit within several months. As one would expect, inflation closely followed the growth of broad
money (Figure 2).
Money and prices
The expansion of the money supply was largely motivated by the growth of reserve money, which
started out as credit to the government, but later expanded to credit to SOEs and the private sector,
as well as large credit expansion to the commercial banks.
Figure 2. Zimbabwe: Reserve Money Growth
(12 month percent change)
Source: RBZ data.
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Figure 3. Zimbabwe: CPI Inflation
(12 month inflation in percent change)
Source: RBZ data and CPI estimates by Robertson (from June 2005)
Foreign Exchange Markets
The Zimbabwe dollar (Z$) exchange rate has gone through numerous adjustments since
independence, but might be considered to have passed through 3 broad exchange rate regimes.
Initially after independence in 1980, it was pegged to a basket of currencies but subject to periodic
devaluations. Beginning in 1994 the exchange market was liberalised and the basket was replaced
with an independent float, and the exchange underwent regular depreciations. Beginning in 1999
the Zimbabwe-dollar was officially pegged to the US dollar but regularly devalued (Noko, 2011). A
fourth period of official dollarization began in January 2009.
During the inflation period of 1998–2008, domestic output declined so imports became more
important and the pass through of exchange rate depreciation to domestic inflation rose. As the
government took to printing money at an increasing rate, the exchange rate became the symbolic
measure of inflation and created a classic inflation-devaluation spiral.
The Zimbabwe authorities did only moved to an officially pegged exchange rate regime in March
1999, well after they broke off their ESAF (Enhanced Structural Adjustment Fund) Program with the
IMF in early 1998. Owing to the high inflation during this period, the pegged rate quickly became
overvalued and was subsequently devalued—a process that continued to repeat itself. The
overvaluation and the corresponding shortage of foreign exchange led to the emergence of an overt
parallel foreign exchange market by September 1999, where the price of foreign exchange more
accurately reflected its scarcity. This period from 1999 through 2008 was characterised by foreign
exchange shortages, regular official depreciations, and a growing parallel market (Figure 4).
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Figure 4. Official versus Parallel Market Exchange Rate
(Z$/US$, increase is depreciation)
Parallel rate
Offical rate
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
1.E+22
1.E+20
1.E+18
1.E+16
1.E+14
1.E+12
1.E+10
1.E+08
1.E+06
1.E+04
1.E+02
1.E+00
Source: Data from RBZ. Rates adjusted to remove effects of currency reforms in 2006 and 2008.
As the banks and RBZ were unable to meet the demand for foreign exchange at the official rate, a
parallel foreign exchange market developed, where the spread typically ranged between 10 and 100
times the official rate (Figure 5). The officially fixed exchange rate, which was overvalued, remained
constant until pressure forced it to devalue to a level more in line with supply and demand.
Normally, a genuine fixed exchange rate requires the central bank to supply foreign exchange in
unlimited amounts at that rate, but this was impossible owing to the excess demand at the official
rate. As a result there was always a queue for foreign exchange, and often only government agencies
and state owned enterprises could obtain foreign exchange at the official rate, if any was available.
Parastatals that earned foreign exchange would be allowed to keep part of their foreign exchange
but were required to surrender the remainder to the central bank. As the money supply continued
to grow and inflation rose, the official exchange rate quickly became overvalued in real terms and
the devaluation process repeated itself.
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Figure 5. Parallel Market Exchange Rate Premium
(ration of parallel to official rate
>1 means a more depreciated parallel rate)
Source: Figure 4.
The data that we show below was supplied by the RBZ as a representative parallel market rate
obtained by survey. Under such conditions, one can understand that multiple parallel market rates
would exist, which raises the question of how such rates become established. One parallel rate was
referred to as the Old Mutual rate, because Old Mutual Insurance was listed on the Zimbabwe stock
exchange as well as the London stock exchange. Thus, the same share could be purchased for
Zimbabwe-dollars and pounds sterling, creating some measure of an implicit exchange rate and
offering arbitragers an opportunity to make money. Such a rate however, necessarily included the
cost of equalising the value of Old Mutual shares in Harare with London. Another parallel exchange
rate was created by the UN for paying local salaries, in order to link its salaries to an underlying US
dollar value. This was used by many international organizations for accounting purposes, and
provides a useful tracking mechanism.
As inflation accelerated, the scarcity of Zimbabwe-dollar bank notes created an additional parallel
rate between transactions done with notes and those done with bank deposits; where the
Zimbabwe-dollar exchange rate was more depreciated when transacting with deposits as opposed
to notes. As a result, a practice, known as “burning dollars” emerged, where arbitrageurs would buy
foreign exchange with Zimbabwe-dollar notes at an appreciated rate and sell those US dollars at a
profit for Zimbabwe-dollar bank deposits. This process could be repeated if one had bank contacts to
obtain more Zimbabwe-dollar notes from your bank deposit. Economic theory tells us that multiple
exchange rates may exist depending upon the reason for their existence, but they tend to converge
if arbitrage is possible.
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Tests of Purchasing Power Parity (PPP)
We can examine some aspect of market rationality by testing to see if the official and parallel market
exchange rates had any relationship to PPP, or the law of one price. Under the PPP hypothesis, the
exchange should move in response to changes in the relative price levels, for which we use the
consumer price indices (CPI).
(1)
NER = k*CPI_Zim/CPI_US
(where the nominal exchange rate (NER) is expressed in Zim$/US$)
This is equivalent to saying that the bilateral real exchange rate (RER) remains constant if PPP holds.
(2)
RER = NER*CPI_US/CPI_Zim
Thus, we calculate the official real exchange rate (RER_Off) and parallel market real exchange rate
(RER_Par) versus the US dollar (Figure 6), and test them for stationarity to determine if PPP holds.
The standard Augmented Dickey Fuller (ADF) test shows that the official market rate is stationary,
using one lag (Table 2). We also tested for trend stationarity but found that the trend was not
significant. On the other hand, the real parallel market rate was stationary around a significant
positive trend, which indicates that there was an underlying (trend) real depreciation taking place.
These results might indicate that the government tried to set the official nominal rate in such a way
as to keep the real rate constant over the long run. However, the parallel market rate showed a
significant long-run structural real depreciation indicating that productivity was probably eroding
and the exchange rate required a real depreciation to maintain competitiveness.
Figure 6. Zimbabwe: Real Exchange Rate
Zimbabwe dollars per US dollars
(An increase implies real depreciation)
Source: Nominal exchange rate data from RBZ; calculation of real exchange rates by authors.
15
Table 2. Augmented Dickey-Fuller Test for Unit Root
For Real Exchange Rate for Zimbabwe
(Excludes last 6 months of data)
Null Hypothesis: There is a unit root (series is not stationary)
a) RER—Offical Rate
ADF test with constant
Null Hypothesis: RER_OFF has a unit root
Exogenous: Constant, Linear Trend
Lag Length: 1 (Automatic - based on SIC, maxlag=12)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-6.221761
-4.031899
-3.445590
-3.147710
0.0000
*MacKinnon (1996) one-sided p-values.
Conclusion: There is no unit root, series is stationary
b) RER—Parallel Rate
ADF Test with constant and trend
Null Hypothesis: RER_PAR has a unit root
Exogenous: Constant, Linear Trend
Lag Length: 5 (Automatic - based on SIC, maxlag=12)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-3.805903
-4.034356
-3.446765
-3.148399
0.0194
*MacKinnon (1996) one-sided p-values.
Conclusion: There is no unit root; series in trend stationary.
_______________________
Source: Calculation by authors, using Eviews . Real effective exchange rate
defined as: Z$/US$*(CPI_USA/CPI_ZIM).
16
Causality
In the hyperinflation process, there is a vicious cycle of money growth (M), inflation (P), and nominal
depreciation (NER) that takes place, which we endeavour to explore further, especially in respect to
the question of causality.
M
P
NER
We use the Granger Causality test to provide some initial insight on the money-inflationdepreciation spiral chain of causality.4 The Granger Causality test requires that the tested series be
stationary. Using the ADF test and Phillips-Peron test, we find that CPI, broad money and the parallel
market exchange rate are all I(2) and the official nominal exchange rate is I(1) trend stationary
(Table 3). Series that are I(2) stationary imply that the levels have constant acceleration upward,
whereas I(1) series have constant velocity. These results seem to make sense for the inflation period
under consideration.5
Table 3. Stationarity Tests for all Variables
Variable
Test
Period
Freq
Order
Lags
Constant
Trend
Signif
level
Other
comments
Zimbabwe Variable
ln(ner_par) ln(m2_zim)
ADF
PP
1998q41998q42008q3
2008q3
Q
Q
I(2)
I(2)
1
1
Yes
Yes
No
No
ln(rer_off)
ADF
1998q42008q2
Q
I(1)
2
Yes
No
ln(rer_par)
ADF
1998q32008q2
Q
I(1)
1
Yes
No
ln(ner_off)
ADF
1998q32008q1
Q
I(1)
1
Yes
Yes
1%
1%
1%
1%
5%
Not I(1) if
incl. all of
2008
PP test
confirms
results
ADF test is
significant
for 19992007
Ln(cpi_zim)
ADF
1998q42007q4
Q
I(2)
1
No
No
ln(gdpr_zim))
ADF
1998q42008q4
Q
I(1)
1
Yes
No
1%
1%
4 Granger causality tells us that the assumed exogenous variable significantly affects the assumed
endogenous
variable, even after lagged values of the assumed endogenous variable are used on the right hand side of the
equation. That is, in the conditional distribution, lagged values of yt add no information to explain movements
of xt, beyond that provided by lagged values of xt itself (Greene, 2012).
5 There would be limited difference in interpretation between being I(1) stationary with a trend and I(2).
17
Table 3. (continued) Stationarity Tests for all Variables
USA Variable
Variable
ln(m2_usa)
Ln(cpi_usa)
ln(gdpr_usa))
Test
ADF
ADF
ADF
Period
1998q4-2008q4 1998q4-2008q4 1998q4-2008q4
Freq
Q
Q
Q
Order
I(1)
I(1)
I(1)
Lags
1
1
1
Constant
Yes
No
Yes
Trend
No
No
No
Signif. level
1%
1%
10%
Other comments
Source: Calculations by authors using EViews. See Appendix 2.
The Granger Causality test was run on pairs of the stationary variables, including 4 lags, with the null
hypothesis of: No Granger Causality. The results for the official exchange rate indicate that changes
in broad money growth Granger causes changes in CPI inflation which Granger causes changes in the
growth of the official nominal exchange rate (Box 1). This would support the PPP test above.
Moreover the Granger causality of money on the exchange rate would support a more monetarist
logic based on the Quantity Theory of Money (below). Secondly, change in growth of the official
nominal exchange rate was being Granger caused by the parallel nominal exchange rate. This would
indicate that the official nominal exchange rate was reacting to money, prices and the parallel
market rate. This makes some sense as the government was setting the official rate based on a PPP
strategy, where money growth was driving inflation.
Box 1. Diagrammatic Presentation of Granger Causality Tests
(Variables refer to second difference of log of variable)
M2
CPI
NER_Off
NER_Par
Notes: Direction of arrow indicates significant causality (at the 5% level)
No arrows indicate no significant causality.
Based on results show in Appendix 2-
Source: Calculated by authors using EViews. All variable are second
the difference of the log of the level of the variable. See Appendix.
Based on the above results, we use the Quantity of Money Theory (QMT) (Equation 3) to examine
the monetarist view that the price level (P) is a function of the level of the money supply (M), the
velocity of money ( ) and output ( ).
(3)
18
Combining the QTM with PPP (Equation 1) implies that the exchange rate is determined by the
relative levels of money supplies, outputs and velocities
(4)
Then
We can estimate Equation 4 in log form and substitute a trend line for the relative velocity term, as
we might expect velocity in Zimbabwe to be rising relative to the USA owing to financial deepening
(Equation 5). Taking the first differences of (5) yields a dynamic equation based on relative rates of
change (Equation 6).
(
(5)
)
[
(
(6)
]
)
(
(
)
)
(
)
(
)
where dl = first difference of the log of the variable, which is the growth rate
We test equation 6 for cointegration and find one cointegrating vector using one lag and a constant
(Appendix Section 4).6 This would substantiate the long-run relationship between the nominal
exchange and relative money growth, based on QTM and PPP. Based on this, we estimate the vector
error correction model for (6) and find the correct sign for the relative inflation variable, with a
highly significant coefficient of about 0.9. This implies that 90 percent of the inflation differential
passes through to the exchange rate. The coefficient on the relative growth term, however, is the
opposite to what was predicted by Equation 6, but not unexpected. According to the quantity
theory, all other things being equal, a decline in output reduces the demand for money, prices fall
and the exchange rate should appreciate (decline), i.e. there should be a negative relationship
between output and the nominal exchange rate. However, if output is collapsing and causing exports
to collapse owing to a range of other factors, while import demand grows, then the exchange rate
will certainly depreciate for balance of payments reasons. In this situation, there would be a positive
relationship between output and the nominal exchange rate. The larger problem for the error
correction model in (6) is the adjustment mechanism of -1.05, meaning full or more than 100
percent adjustment takes place every period, indicating over-adjustment and likely instability. We
have some concerns about the overall stability of the model, but think that the relationship between
money and the exchange rate is being appropriately captured by the model. This would tend to be a
typical characteristic of hyperinflation: printing money flows through to the exchange rate and price
level almost equally.
6 The model is estimated from 1998 to2007q4 because the data in 2008 are partially estimated and of much
weaker quality.
19
Table 4. Zimbabwe: Quantity of Money Error Correction Model
Long-Run Cointegrating Equation for dlog(ner_par)
Variable
Coefficient
Constant
-0.15
dlog(cpi_zim/cpi_usa)
+0.89
dlog(gdpr_zim/dgdpr_usa)
+3.40
t-statistic
3.1
14.2
2.19
Significance level
>1%
>1%
>5%
ECM for d2log(ner_par)
Long-run cointegrating equation =Error
-1.05
-2.7
>5%
correction term-α
d2lner_par
+.22
.83
n.s.
d2lm2_zim_usa
-1.22
2.3
1%
d2lgdpr_zim_usa
-1.05
-2.7
>5%
R-squared
.34
Source: Calculated by authors in EViews, see Appendix Section 4. dlog=first difference of log of
variable; d2log = second difference of log of variable.
THE IMPOSSIBLE TRINITY HYPOTHESIS
Zimbabwe’s economic policy from 1998 to 2008 might look more ingenious if we consider that the
authorities were trying to follow an economic model along the lines of China or the former Soviet
Union (FSU), which can be put into the context of the “Impossible Trinity Hypothesis” (ITH). The ITH
is an outcome of the Mundell-Flemming model of open-economy macroeconomics, which suggests
that an economy cannot maintain a (1) fixed exchange rate, (2) free capital movement, and (3) an
independent monetary policy simultaneously—although any two are possible (Figure 7).
Of the 3 potentially desirable policy goals, the choice is usually understood as being between
monetary policy independence or a fixed exchange rate, given the existence of capital mobility
(Aizenman, et al., 2011). In this normal choice, the free movement of capital prevents a country from
both maintaining a constant exchange rate and freely controlling its interest rates, as deviation of
interest rates from that of its partners causes capital flows that strengthen or weaken the exchange
rate.
20
Figure 7. Impossible Trinity
Capital Mobility
Floating
exchange
rate regime
Monetary
Union
Monetary independence
Fixed Exchange Rate
Closed financial markets
And pegged exchange rate;
Source: Aizenman, Chin and Ito
However, a country might theoretically maintain exchange rate stability and monetary autonomy if it
can exercise full control over capital flows, as is broadly the case in China today (Hung, 2008) or
previously in the former Soviet Union. Even the original Bretton Woods system provided some
monetary autonomy and exchange rate stability by limiting capital mobility. When the capital
account is tightly closed, there is no possibility of foreign exchange escaping, so the exchange rate
and monetary policy can be set largely independently of the rest of the world. Thus, in a situation of
a closed economy, reminiscent of the FSU, the official exchange rate can be completely controlled,
as the government makes decisions based on rationing and shadow prices, with market prices
playing a minor role. Under such autarky, the closed capital account takes on critical importance
within the ITH, and many economic decisions begin to look like rationing.
It would appear that Zimbabwe was trying to pursue a strategy of closing its capital account in order
to control both its monetary and exchange rate policy at the same time. However, simply legally
closing the capital account is insufficient to halt capital flows, as they can fairly easily, albeit illegally,
escape through the current account. The FSU and China were more successful at controlling capital
flows because those governments also controlled a large share of the means of productions,
including the banking system and therefore could limit illegal capital flows. If the government could
halt all unauthorised capital flows and parallel markets, then the domestic interest rate would not
have any impact on capital flows and the exchange rate could be fixed consistent with a desired
current account balance.
There is some evidence to support the hypothesis that Zimbabwe tried to follow such a policy. Using
the Chinn-Ito data on capital account openness (Chinn-Ito, 2008),7 we observe that Zimbabwe
dramatically increased capital account exchange controls in 2003—i.e., they reduced capital account
7 The Chinn-Ito index is a measure of the degree of openness of a country’s capital account. The index ranges
from a value of 2.46 which indicates “most financially open” to -1.86, indicating “least financially open”.
Zimbabwe’s Chinn-Ito index score ranges from -1.159 (prior to 2003) falling to -1.86 (2003 – 2008), recovering
to -1.159 in 2009 and improving even further to -0.1 in 2010. The index is based on binary variables to codify
the tabulation of restrictions on cross-border financial transactions reported in the IMF’s Annual Report on
Exchange Arrangements and Exchange Restrictions.
21
openness (Figure 8). The decline in openness that occurred in 2003 was due to the exchange
controls that were introduced on November 30, 2002, when the government closed all bureaux de
change. This limited licenses to deal in foreign exchange to banks, further affecting the convertibility
of the Zimbabwean dollar (Noko, 2011).
We also note that the capital account was reopened in 2009 after the dollarization of the economy,
signalling an end to the isolationist policy and a re-entry into the world economy. So there was clear
evidence of an attempt to close the capital account as the hyperinflation gained momentum.
Figure 8. Zimbabwe: Chinn-Ito Index of Capital Account Openness
(0=closed, 1 = open)8
Source: Chinn-Ito (2008)
The Chinn-Ito data is further re-enforced by data on the overall index of exchange restrictiveness,
compiled by Ellyne and Letete (2012), which show a rising level of exchange control restrictiveness
that peaks in 2007 and subsequently falls rapidly in the dollarization period (Figure 9)
8 Graph is based on the normalised KAOPEN data of the Chinn-Ito index.
22
Figure 9. Zimbabwe Overall Index of Exchange Restrictiveness
65.0
60.0
55.0
50.0
45.0
40.0
35.0
30.0
25.0
20.0
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Source: Ellyne and Letete (2012)
The data on exchange and capital controls show that they intensified as the hyperinflation
progressed, in order to protect the official fixed exchange rate. However, this attempt at maintaining
control of the capital account was largely unsuccessful owing to foreign exchange leakages brought
about by the existence of an illegal but widespread parallel exchange rate market and the difficulty
of fully closing the capital account in today’s highly globalized world. Given the historical ties
between Zimbabwe and South Africa and their porous shared border, it is understandable that they
could not effectively stop capital flows of cash with South Africa. The authorities’ inability to regulate
such balance of payments flows is further evidenced in the post-2008 balance of payments data,
which shows extremely large errors and omissions. Thus, the result of the government’s
expansionary monetary policy and failure to effectively close the capital account was capital flight
and a destabilization of the economic system.
The Dollarization Exit Strategy
The Zimbabwe hyperinflation ended painfully and slowly during 2008. Annual (year-over-year)
inflation surpassed [100,000] percent in January 2008 and accelerated to 11 million percent by June,
after which most attempts to measure it become meaningless.9 According to best estimates, the
month-to-month inflation rate first surpassed 100 percent, reaching 135 percent or an annual rate of
1.2 million percent, in October 2007. The month-to-month inflation rate rose to an estimated 2,600
percent in June 2008, and may have peaked at 20,000 in September 2008,10 the equivalent of about
25 percent increase in prices per day (based on 22 working days in the month). One hears stories of
shops raising prices twice a day.
9 Estimates until mid-2008 come from John Robertson.
10 We don’t have the same data from which Hanke and Krus determined the 7.96x10 10 monthly inflation rate
in November.
23
Despite the astronomical hyperinflation, there was a notable lack of a government stabilization plan
to reduce inflationary expectations and restore faith in the domestic currency. The government did
make several attempts at currency reform (removing zeros from the notes),11 but these reforms
were not accompanied by any serious stabilization program to prevent printing more money.
Ultimately, the government simply succumbed to the unofficial dollarization that had been taking
place in the private sector. This may be an indication that senior policy-makers lacked incentive to
alter the economic situation because they were directly benefiting from the hyperinflation and the
multiple foreign exchange markets.
By 2008, the private sector had completely lost confidence in the Zimbabwe-dollar, but it remained
the official legal tender of the country, and as such, all domestic payments were to be made in
Zimbabwe dollars. As previously shown, the premium between the official rate and the parallel
market rate reached as high as 4,000 times the official rate, indicating the extent to which the
official exchange rate was divorced from reality. However, the government and SOEs were still
required to provide public services in Zimbabwe-dollars, priced at the official exchange rate. Many
public enterprises and utilities went bankrupt at official prices because they could not obtain needed
imports at the official exchange rate. As the provision of public services disappeared, the private
sector refused to pay for utilities and taxes, leaving behind wide ranging arrears to many public
utilities. The government exchange rate policy ultimately decimated the public sector as well as the
private sector. As the Zimbabwe-dollar became increasingly meaningless, goods disappeared from
the shops and the formal economy ground to a halt by mid-2008: there were literally no goods in
shops at Zimbabwe-dollar prices.
In desperation, the government permitted the use of foreign currency for domestic payments in
January 2009 and goods started to reappear in shops. By April 2012, 5 foreign currencies were made
legal tender for domestic transactions and use of the Zimbabwe dollar simply stopped.12 This
government decision appears to have come about largely by default and simply followed the
behaviour of the private sector. There is little evidence of any strategic government policy to exit the
hyperinflation, except that another currency reform was done in February 2009, where 12 zeros
were removed from the currency.
At the time of introduction of foreign currency payments, there were large amounts of Zimbabwedollar bank deposits, which remain frozen to date because there is no agreement on what rate to
convert them into foreign currency. The difference in using the official versus the parallel market
rate could be thousands of times different. At the beginning of 2013, there are still wide-ranging
cross debts of the private sector to the public utilities and the banks to its depositors that need to be
resolved following the official dollarization. The final decision of the government to dollarize was an
admission of its inability to manage monetary and exchange rate policy.
The resulting multicurrency dollarization is different from most other dollarization schemes, which
usually restrict the official legal tender to the “dollar” currency alone or else in combination with a
local currency. Although the Zimbabwe scheme technically allows payment in any of 5 currencies,
11
The first currency reform in August 2006 removed 3 zeros; the second currency reform in August 2008
removed 9 zeros; and short-lived currency reform in January 2009 removed 9 zeros. All data in this paper have
been adjusted to remove the effect of the currency reform, i.e. go back to pre-August 2006 Z$s.
12 The 5 official currencies are: US dollar, South African rand, Botswana Pula, pound sterling, and the Euro.
24
the government and the banks shifted there accounting systems to US dollars, effectively making it
the official currency. Other currencies, which may be accepted as a means of payment, are then
converted into US dollars at some exchange rate—often at relatively arbitrary rates.13 Slowly
businesses are moving toward a single means of payment; otherwise they stand to incur ongoing
domestic exchange valuation risks by transacting and holding multiple currencies.
Dollarization is the hardest form of a currency peg, as it is leaves no scope for exchange rate
manipulation and implies the formation of currency union with the economy whose currency is
being used. The benefits and costs of dollarization have been widely discussed in the literature
(Honda & Schumacher, 2006). Proponents of dollarization argue that it reduces inflation to that of
the host currency, it boosts exports, and the resulting improvement to confidence and fiscal
credibility results in lower interest rates, increases foreign investment and improves growth.
The above benefits were initially achieved by dollarization, but there are also considerable costs to
dollarization (Table 5). The increased price stability that is gained may come at the expense of
increased output volatility, as the stabilizing effects of monetary policy are lost and only fiscal policy
remains. Seigniorage income, or the government windfall from creating new national money is also
lost. The central bank loses its role as lender of last resort, as it can no longer rescue banks by
printing or loaning unlimited amounts of money. In addition, a dollarized currency is effectively a
fixed exchange rate regime and does not allow for smooth responses to external shocks, which a
flexible exchange rate would better accommodate. The RBZ no longer functions as a central bank
(there are no Zimbabwe dollars) and its foreign liabilities (to the IMF) are larger than its foreign
reserves, creating a negative net worth. Nonetheless, the central bank still continues its role to
supervise the banking system and undertake financial sector surveillance.
Table 5. Summary of Benefits and Costs of Dollarization
Benefits
Costs
No exchange rate volatility vs the dollar—may
Loss of control over monetary policy; including
enhance exports
money supply and interest rates
Inflation generally reduces to that of host
Loss of seignorage revenue
currency
Enhanced credibility over monetary and
Loss of lender of last resort ability by central
exchange rate policy
bank
Increases fiscal discipline
May increase international economic integration
Source: Compiled by authors
13
Need to keep larger amount of foreign reserves
or pay for precautionary international credit
lines
No exchange rate to act as shock absorber
For example, private business frequently accepted South African rand at a rate of 10 per US dollar as
opposed to the official rate. In 2012, this amounted to a 12% surcharge on use of the rand.
25
CHOICE OF EXCHANGE REGIME
Finally, we briefly review Zimbabwe’s dollarization exit strategy in respect to the theory of optimal
currency areas (OCA). The decision to use a fixed exchange rate or use the currency of another
country is usually linked to a choice about regional integration.14 Most African countries see some
long-run advantage from greater regional integration and have mandated the African Union to move
to a common African currency and monetary union by 2028 (ADM, 2012). Under this strategy, some
5 regional economic communities would be created and then merge together to form an African
Economic Union.15 It is thus peculiar that Zimbabwe has essentially chosen to form a currency union
with the United States of America at this time rather than join the regional Rand zone.
Optimal Currency Area Policy
Traditional “optimal currency area” theory tells us that countries that are highly integrated with
others, i.e., have a large share of their foreign trade together, can benefit from a common currency
(Mundell 1961; McKinnon 1963). In general those benefits are seen as reduced exchange rate
uncertainty and lower transactions costs of foreign trade, reduced price discrimination, greater
liquidity, and larger markets. On the other hand, a common currency means loss of the exchange
rate as a policy instrument.
Is regional integration a good strategy for Zimbabwe? While most African countries see some longrun advantage from greater regional integration, the process of yielding sovereignty to supranational organization is politically difficult and takes considerable time. Smaller countries typically
are international price-takers and must adjust rapidly to international price shocks, especially
commodity producers who suffer from more frequent external shocks. Being part of a larger
monetary union can provide a cushion for them. Additionally, countries that are less well-managed
or have weaker institutional structures will benefit more from a strong monetary union. As part of a
fixed exchange rate bloc, countries may benefit from slower adjustment.
The benefits of a currency union are fairly well documented in the literature. Rose (2000) finds a
large positive effect of a currency union on international trade and a small negative effect of
exchange rate volatility after controlling for a host of features “…trade is over 3 times higher
between common currency countries.” Tsangarides, Ewenczk and Hulej (2006) find that “Countries
belonging to the same currency union trade about 2 times more with each other than do other
comparable countries that do not share a common currency.” Currency unions are associated with
trade creation, trade stability, and increased co-movement of prices. Currency unions also tend to
induce financial integration, which has trade-creating effects
The big question for Zimbabwe is whether multicurrency dollarization (dominated by the US dollar)
was the optimal policy. In this event, Zimbabwe has essentially formed a currency union with the
USA. Yet, Zimbabwe’s largest trading partners are China (for exports) and South Africa (for imports).
One might argue that US dollarization is a pseudo peg to the Chinese yuan, and the gradual
appreciation of the yuan against the US dollar is good for Zimbabwean exports.
14 Regional integration generally progresses from a free trade area (without any necessary exchange rate linkages), to a
customs union, to a monetary union (with a common currency and common monetary policy), and finally to an economic
union (with free movement of all factors of production). There may be numerous intermediate steps along the way.
15 The 5 RECs include: CoMESA, SADC, ECOWAS, ECCAS, EAC
26
However, traditional OCA theory would argue that monetary unions perform best when member
countries are in close geographical proximity and experience similar economic shocks, thus naturally
supporting a similar economic policy. In addition OCA theory would expect there to be a high degree
of capital mobility–both human and non-human—to support the adjustment process. Zimbabwe
fails to meet these requirements for the US dollar. Why didn’t Zimbabwe try for greater regional
integration in SADC.
SADC Regional Integration and the CMA
Zimbabwe has been a member of SADC since 1980 and has generally been a supporter to SADC
integration despite the criticism SADC has levied on the Zimbabwean political situation. However,
there is no SADC monetary union at present, but next to Zimbabwe there is the Common Monetary
Area (CMA) rand zone, which functions like a hybrid monetary union (ADM, 2012).16
Table 6. Measures of SADC Country Size and Wealth, 2010
Measures of Size and Income, 2010
Current GDP
in millions of
current US
dollars
41,716
16,193
9,729
14,857
937
382,182
363,704
12,701
3,645
2,132
151,480
23,057
9,586
5,106
7,474
8,721
84,391
13,145
575,378
Real GDP
in millions of
constant 2000 US
dollars
13,134
5,587
6,631
841
75
196,215
187,234
6,089
1,846
1,046
73,677
19,955
9,117
2,744
4,082
5,027
25,901
6,851
283,026
Liberalised
Zambia
Mauritius
Botswana
Seychelles
CMA
South Africa
Namibia
Swaziland
Lesotho
Other Non-Liberalised
Tanzania
Mozambique
Malawi
Zimbabwe
Madagascar
Angola
DRC
TOTAL
Source: World Bank, African Development Indicators.
Population
in millions
GDP per capita
in current US
dollars
16.3
12.9
1.3
2.0
0.1
55.7
50.0
2.3
1.2
2.2
201.5
44.8
23.4
14.9
12.6
20.7
19.1
66.0
273.5
2,559
1,255
7,484
7,429
9,370
6,861
7,274
5,522
3,038
969
752
515
410
343
593
421
4,418
199
2,104
16 The CMA comprises South Africa, Namibia, Lesotho and Swaziland. It is a free trade area
movement of capital but not labour mobility.
with free
27
The CMA is a well-established institution that has worked very well for almost 50 years, despite
political changes, and thus provides policy credibility and institutional depth to any new member.
South Africa manages CMA monetary policy, has a sophisticated financial system, and follows an
inflation targeting regime that has produced relatively low inflation over the past decade. All CMA
member countries converge to the South African inflation rate, which is one of the lowest in the
region. One could say that Johannesburg serves as a “London” financial centre for Africa, which
deepens the financial market and improves availability of capital in the region (at competitive rates).
Additionally, South Africa is also one of Zimbabwe’s largest trading partners, and therefore by
joining the CMA Zimbabwe would benefit from a fixed Rand exchange rate. These factors make it
realistic to begin with the Rand zone as an optimal currency area for Zimbabwe as well as a possible
currency for SADC regional integration.
The CMA model is interesting because it is not a full-fledged monetary union but a hybrid model that
offers certain benefits to members. Every country has its own central bank and its own currency—
key institutions that most countries are reluctant to abandon. The CMA operates more like a hard
peg,17 but has had all the benefits of a monetary union for its members. It is a free trade area with a
common external tariff wall and has free movement of capital with a common set of exchange
controls. The common set of exchange controls provides some desirable level of security against
capital flight and illegal cross-border transactions.
It should not be any different for Zimbabwe to operate in rand than in US dollars. It would mainly
require that the government shift to a policy of single currency dollarization, the rand, and begin
some cooperation with the South African Reserve Bank. Zimbabwe would remain dollarized (in rand)
but might consider minting its own coins in the future. It must establish a credible track record of
economic management before thinking about re-introducing the Zimbabwe-dollar, even within the
context of the CMA. The government might also consider joining the Southern Africa Customs Union
(SACU) to provide obtain some corresponding fiscal integration, although this is not absolutely
necessary to participate in the monetary union.
South Africa is Zimbabwe’s largest supplier of imports, it is geographically close, and is an important
source of worker remittances. Most importantly, Zimbabwe looks more like South Africa from an
economic structural point of view—both countries look like commodity exporters--and it more
closely follows SA’s business cycle. This means that a South African monetary policy and rand
exchange rate would be more appropriate for Zimbabwe than the US dollar and its monetary policy.
OCA theory would support Zimbabwe joining the CMA rand-zone rather than the USA dollar zone. A
South African monetary policy would seem more appropriate for Zimbabwe than US monetary
policy, more liquidity would be available within the CMA, and Zimbabwe would obtain recognition
for following a credible monetary policy as part of the CMA. No doubt there will varying economic
impacts on different sectors of Zimbabwe’s and SA’s economies. It is to be expected that various
sectors of the economy might incur varying benefits and costs. However, joining the rand zone
should provide net benefits by providing lower cost trade, greater liquidity, more investment
resources, and monetary policy credibility.
17
The CMA is also like a currency board that requires more-or-less full foreign currency cover for the local
currency in circulation.
28
While the dollarization strategy successfully halted Zimbabwe’s hyperinflation, it is not an ideal longterm solution for the country, whereas contributing to African regional integration might be a better
long-term strategy. Moreover, Zimbabwe policy-makers are still confronted by several important
economic problems under the multi-currency dollarized system.
CHALLENGES OF DOLLARIZATION
The main constraint to growth cited by most Zimbabwe businesses is the lack of liquidity and finance
for working capital and new investment. It is not surprizing that liquidity management is
problematic, as it is a monetary policy issue and there is no domestic management of monetary
policy under a dollarized system. Investment is similarly linked to monetary policy through the
interest rate, but depends critically on other structural policies, like the indigenization policy, which
appears to be problematic.
Balance of Payments
Creating liquidity in a dollarized economy requires a balance of payments surplus. Thus, the first big
challenge to policy-makers is to create an overall balance of payments surplus,18 which is most
appropriately done by creating a structural current account surplus. However, Zimbabwe’s current
account was officially in deficit in 2010-12, which indicates a fundamental structural problem for a
dollarized economy. If there is a genuine overall balance of payments deficit, then the economy
may, in fact, be deflating.
However, there is some evidence that there are substantial missing current account inflows, possibly
from worker remittances, because the ‘errors and omissions’ is highly positive. Many experts
suspect that large unrecorded remittances from outside the country (mainly South Africa) are
funding imports. Alternatively, there may be large amounts of capital that have already left
Zimbabwe as private sector reserves and these are being used to pay for imports. If so, those
reserves will eventually be exhausted.
The interpretation of the overall balance of payments needs to be redefined in the Zimbabwean
context, because the RBZ is essentially not playing any financial role. In principle, the commercial
banks take over the role of the central bank, and foreign reserves become private foreign reserves.
Thus private capital held offshore will require a capital outflows by the commercial banks. In fact,
when commercial banks hold 25 percent of their deposits as liquid assets, they frequently do that by
holding them in the form of nostro accounts offshore. When dollars are needed for imports, it is the
funds from these accounts that provide the part of the foreign exchange for them.
Monetary Management
The dollarization of the economy has effectively eliminated the role of the RBZ in monetary policy,
as it has no supply of instruments or cash US dollars that can be used for open market operations to
manage the money supply. Because the local currency is the US dollar, the RBZ is no longer the
lender of last resort, as it had been with its own currency. For the most part, the monetary
authorities have no control over domestic liquidity.
18
Normally, this refers to an increase in official reserves, but could equally refer to private bank reserves, as
the RBZ is currently not in a position to accumulate reserves.
29
However, there is still a domestic banking system money multiplier; because Zimbabwe operates a
fractional reserve banking system that creates new deposits (i.e. money). Loans for domestic
purchases create a deposit multiplier effect, whereas loans for imports flow out of the country.We
can begin to understand the money creation process from the accounting for the standard money
multiplier for an economy with its own currency. In the traditional case, the money multiplier (mm)
is the ratio of broad money (M2) to reserve money (RM).
(1) mm = M2/RM
Broad money is composed of customer deposits (D) and cash (C) or currency in circulation (2), while
reserve money comprises cash and bank reserves (R) held at the reserve bank (3).
(2) M2 = D + C
(3) RM = C + R
By incorporating the reserve ratio (r=R/D) of required reserves to deposits and the cash ratio (c=C/D)
of cash to deposits, we can obtain a formula for the money multiplier for a local currency, based on
these ratios (4).
(4) mm = (D+cD)/(cD+rD) = (1+c)/(r+c)
For Zimbabwe, the above formula provides the basis for the banking system money multiplier. If we
knew the amount of US dollar notes in circulation we could exactly calculate the money multiplier.
Ignoring the impact of currency in circulation for the moment, as it is unknown, the domestic money
multiplier for banks creating new deposits is simply the inverse of the reserve ratio (5), which is the
liquidity ratio in the Zimbabwe case.
(5) (1/r)
Since the required liquidity ratio is 25 percent, the domestic money multiplier for new deposits
brought into the banking system is 4.
The desire of private agents to hold part of their deposits as cash (the cash/deposit ratio) tends to
reduce the money multiplier. We know that the cash ratio rose from 0.08 in 1999 to 0.33 in 2007 for
the Zimbabwe dollar. Assuming a similar cash/deposit ratio for US dollars, the true money multiplier
might lie between 3.3 (=1.08/.33) and 2.3 (=1.33/.58), based on equation (4). Given the present lack
of confidence in the banking system and the potentially high cash/deposit ratio, the money
multiplier is probably closer the lower end of this range.
The key issue for policy-makers to understand about the Zimbabwe financial system is that bankcreated dollar deposits are not really equivalent to US dollars. If they were, wouldn’t every country
be creating US dollar this way? These US dollar deposits created in Zimbabwe can function perfectly
well for domestic transactions, in the same way a local currency would function. They depend on
confidence in the government and in the domestic financial system. However, one cannot
necessarily use those deposits for imports or for a capital outflow unless they are backed by real US
dollars, which depends on the balance of payments and private foreign reserves. Only dollars earned
through the balance of payments can be used to purchase imports.
30
Thus, there is a potential danger of producing too many US dollar deposits created in Zimbabwe
without sufficient balance of payments earning, because those deposits do not have international
purchasing power. No one can see the difference between US dollars earned through the balance of
payments and those created through banking money multiplier, but only those dollars earned
through the balance of payments can be used for purchase of imports because they are backed by
foreign exchange.
The government’s attempt in 2012 to create of a US dollar treasury bill market19 posed the danger
of either creating too many US dollar deposits through the money multiplier by such domestic bank
lending, or the risk of crowding out private borrowing. Under a dollarized system, the government is
usually obliged to run a balanced budget because it receives no seignorage and cannot print money
to pay its debts. Basically, the government is no longer the risk-free borrower. In fact, lending to the
government may entail similar risk as lending to a large corporation—hence the demand for similar
high interest rates. Of course the government can finance the budget by borrowing dollars on
international credit markets (a balance of payments transaction), but the government cannot pay its
current external debt service and thus is unlikely to find such any foreign lenders.
Other government ideas in 2012, like capping lending rates or confiscating banks’ nostro accounts
are also dangerous initiatives that circumvent real economic progress and development, and risk a
banking crisis in the process. Interest rates are high because the amount of real US dollars available
to borrow is limited to those earned through the balance of payments. If too many domestic dollar
deposits are created through the money multiplier, when private agents try to use those deposits to
pay for imports and there is insufficient backing, there will be a loss of confidence in the banking
system. Any attempt to confiscate the banks’ nostro accounts and use them for government
spending or lending that does not generate export earnings will only accelerate the demise of the
banking system.
Investment
A third major policy challenge facing policy-makers is increasing investment. We have noted that
domestic liquidity is short supply in a dollarized economy, so foreign borrowing and foreign direct
investment should be important sources of investment. In this regard, the impact of the
government’s “indigenization policy,” which requires 51 percent domestic ownership, would
technically reduce the amount of foreign inflows that would otherwise come into the country.
Moreover, the indigenization policy would authorise major capital outflows by mandating domestic
entrepreneurs to purchase 51 percent of foreign-owned enterprises, who would then externalize
that money.20
The indigenization policy would necessarily reduce the net capital inflows in the balance of
payments. A strategy of reducing net capital inflows when more are needed seems strange, but
might be interpreted as a time preference decision by the authorities, whereby they prefer long-run
dividends to stay in the country over increasing short-run investment. The authors do not think that
19 The government’s attempt to
create a treasury bill market in November 2012 failed because the banks
demanded yields of 12 to 15 percent, which the government regarded as too high, and rejected most of the
bids--luckily.
20 ZANU-PF promotes the indigenization policy, MDC does not.
31
this is the right trade-off for the present situation, when domestic investment and liquidity are
desperately needed.
The government also sharply raised the minimum capital required for banks in 2012, from US$[10]
million to US$100 million. This may turn out to be a prudent step for the long run. Some analysts
said that his action was intended to force foreign banks to bring in more capital and expand their
domestic lending. However, a majority of the banks in the country are small domestic banks, who
will not be able to raise such large amounts of capital. They will be forced to consolidate into a
smaller number of domestic banks, or will be bought by foreign banks. As noted earlier, without a
lender of last resort in Zimbabwe, banks must essentially self-insure and this is easier for branches of
foreign banks than for domestic banks.
CONCLUSIONS
Zimbabwe notably achieved the second highest hyperinflation in recorded history. This paper set out
3 possible explanations for the hyperinflation that occurred between 1998 and 2008: (1)
government policy-makers did not understand the full implications of their monetary policy; (2) the
government policy-makers were trying to fix the exchange rate and manage monetary policy under a
closed capital account, which they couldn’t effectively close; or (3) the government understood that
it was benefiting by printing money at an accelerating rate to fund SOEs and the civil service.
Based on the background conditions leading up to the full hyperinflation—including an unfinanced
war, a dysfunctional land reform program, and a new political challenge—the government chose to
take the easier strategy of high fiscal spending financed by printing money. They disguised part of
the excessive fiscal spending through central bank loans to SOEs and private enterprises. The
resulting exponential growth of the money supply coming through the public sector meant that the
private sector was effectively losing purchasing power. This ultimately led to excessive government
debt and a collapse of output—not unlike other cases of hyperinflation in the past.
A unique characteristic of this hyperinflation was the multiple exchange rate markets that allowed
many SOEs and government-connected insiders and to benefit from access to foreign exchange at
the overvalued official rate. Because the parallel exchange rate frequently carried a premium of 10
to 100 times the official rate, anyone able to obtain foreign exchange at the official rate could readily
make a good profit by selling it on the parallel market or purchasing labour cheaply in Zimbabwedollars. However, because there was little or no value-added in this arbitrage process, compared to
the size of the profits being made, there was an implicit zero-sum game whereby some other
economic agents lost value added. This paper identified the main losers as those who operated
solely in the Zimbabwe-dollar sector, as the product of their labour was expropriated at a discount.
The economic agents who had access to foreign exchange could often benefit from the inflationdepreciation spiral or at least hedge themselves against loss of purchasing power.
As inflation accelerated, the process of dollarization in the private sector increased and the parallel
market expanded. The government could hardly have been ignorant of what was happening, as
official annual inflation broke 100 percent by end-2001, as did growth in the money supply. Yet the
government continued to pursue a fixed exchange rate policy with regular devaluations, without
taking any significant steps at economic stabilization, despite the intensification of the inflation. By
32
early 2007, about a year before elections were to be held, the inflation rate surpassed 50 percent
per month (about 12,900% annualized) along with money growth and depreciation.
We examined the money growth-inflation-depreciation spiral as well as testing the purchasing
power parity hypothesis to try to understand the logic of this spiral. We deduced that the
government appeared to be setting the official exchange rate on a PPP basis, whereas the parallel
market rate was showing an underlying real depreciation that probably reflected the deteriorating
productivity of the economy. In addition to PPP, it appeared to us that the Quantity Theory of
Money hypothesis also held, which indicated that money growth was also directly driving the
exchange rate depreciation. We noted that the decline in output had the impact of reducing export
capacity and raising the demand for imports, thus furthering a real depreciation.
We examined the proposition that the government may have been trying to close the capital
account in an attempt to control both the exchange rate and monetary policy, perhaps trying to
follow the model of the Chinese or the former Soviet Union, where it worked with some success. In
this regard, we examined the “Impossible Trinity Hypothesis.” While it looked like the government
had increase exchange controls in an attempt to close the capital account, it was not able to
effectively do it in Zimbabwe, owing to the developed parallel exchange markets and numerous
escape routes for capital flight. Moreover, too many “insiders” were benefitting from the spread
between the parallel and official exchange markets to truly close that loophole. As a result, the
inflation-depreciation spiral reached astronomic levels and the economy wound further downward.
We observed that the dollarization exit strategy appears to have been done more out of default than
calculation. The decision to have 5 currencies as part of the official dollarization, with the choice of
using the US dollar as the main currency as opposed to the South African rand, appears to show little
consideration of optimal currency area theory. Moreover, the official dollarization policy requires
that the balance of payments should generate an overall surplus in order to increase domestic
liquidity, yet the official balance of payments shows a shockingly high current account deficit of over
25 percent of GDP. Although we noted likely technical reasons explaining the high errors and
omissions, the current account deficit is necessarily a very worrisome factor.
We examined two main economic challenges in the dollarized period: (1) the need for more
investment and (2) the lack of domestic liquidity. In response to the first, the ZANU-PF policy-makers
have promoted an “indigenization policy,” that dampens foreign direct investment and reduces net
capital inflows, which we thought could be counter-productive in the near term.
Policy makers have tried to increase domestic liquidity by prodding the domestic banks to lend
more, which is to say that they are trying to increase the money multiplier for creating domestic US
dollars deposits. There seems to be an idea that the government can increase the growth of the US
dollar money supply through the money multiplier without a corresponding balance of payment
surplus.21 In this regard, policy makers tried to launch a domestic US dollar treasury bill market in
2012, which fortunately did not succeed. This effort to expand liquidity is bit reminiscent of the
earlier inflation period.
21 We explain that US dollar deposits created in Zimbabwe do not have the international
genuine US dollars unless they are backed by a balance of payments surplus.
purchasing power of
33
In conclusion, we have identified a number of policies that seem to demonstrate that government
policy-makers are still resorting to politically expedient solutions without considering their
underlying economic implications. Thus we fear that the Zimbabwe economic crisis may not be over.
The present current account deficit, the pressure to create faster monetary growth through
domestic dollar deposits, and the indigenization policy as a response to investment needs may
create new crises for Zimbabwe. Under the circumstances, we believe that the one prudent course
of action for Zimbabwe’s economic policy would be to follow a regional integration policy by joining
the CMA rand zone and subjecting itself to the guidance of the South African Reserve Bank.
34
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Appendix I
36
APPENDIX I: EVIEWS TECHNICAL OUTPUT
1. Unit Root Tests
Log(RER_Official) is I(1))
Null Hypothesis: D(LRER_OFF) has a unit root
Exogenous: Constant
Lag Length: 1 (Automatic - based on SIC, maxlag=9)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-9.554832
-3.610453
-2.938987
-2.607932
0.0000
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(LRER_OFF,2)
Method: Least Squares
Date: 01/31/13 Time: 11:08
Sample (adjusted): 1998Q4 2008Q2
Included observations: 39 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D(LRER_OFF(-1))
D(LRER_OFF(-1),2)
C
-2.763624
0.968974
-0.083911
0.289238
0.206511
0.151648
-9.554832
4.692119
-0.553328
0.0000
0.0000
0.5835
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.759632
0.746278
0.937426
31.63562
-51.25768
56.88519
0.000000
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
0.145822
1.861050
2.782445
2.910411
2.828358
1.470964
Appendix I
37
Log(RER_Parallel) is I(1)
Null Hypothesis: D(LRER_PAR) has a unit root
Exogenous: Constant
Lag Length: 1 (Fixed)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-5.562379
-3.605593
-2.936942
-2.606857
0.0000
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(LRER_PAR,2)
Method: Least Squares
Date: 01/30/13 Time: 19:40
Sample (adjusted): 1998Q4 2008Q3
Included observations: 40 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D(LRER_PAR(-1))
D(LRER_PAR(-1),2)
C
-1.021100
0.384393
0.059137
0.183573
0.151067
0.044862
-5.562379
2.544525
1.318205
0.0000
0.0152
0.1955
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.464192
0.435229
0.275148
2.801133
-3.580432
16.02726
0.000010
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
-0.001722
0.366125
0.329022
0.455688
0.374820
1.888879
Appendix I
38
Log(NER_Official) is I(1)
Null Hypothesis: D(LNER_OFF) has a unit root
Exogenous: Constant, Linear Trend
Lag Length: 1 (Fixed)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-4.991468
-4.034356
-3.446765
-3.148399
0.0004
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(LNER_OFF,2)
Method: Least Squares
Date: 07/31/13 Time: 19:19
Sample (adjusted): 1998M04 2008M06
Included observations: 123 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D(LNER_OFF(-1))
D(LNER_OFF(-1),2)
C
-0.992764
0.128650
-0.191669
0.198892
0.170195
0.181146
-4.991468
0.755899
-1.058090
0.0000
0.4512
0.2922
Appendix I
39
Log(NER_Parallel) is I(2)
Null Hypothesis: D2LNER_PAR has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=9)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-5.430229
-3.610453
-2.938987
-2.607932
0.0001
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(D2LNER_PAR)
Method: Least Squares
Date: 01/31/13 Time: 11:27
Sample (adjusted): 1998Q4 2008Q2
Included observations: 39 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D2LNER_PAR(-1)
C
-1.065243
0.121526
0.196169
0.099137
-5.430229
1.225838
0.0000
0.2280
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.443503
0.428463
0.613256
13.91506
-35.24209
29.48738
0.000004
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
0.047663
0.811184
1.909851
1.995162
1.940460
1.704356
Appendix I
40
Log(M2_ZIM) is I(2)
Null Hypothesis: D2LM2_ZIM has a unit root
Exogenous: Constant
Lag Length: 1 (Fixed)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-6.254674
-3.626784
-2.945842
-2.611531
0.0000
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(D2LM2_ZIM)
Method: Least Squares
Date: 01/30/13 Time: 19:59
Sample (adjusted): 1999Q1 2007Q4
Included observations: 36 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D2LM2_ZIM(-1)
D(D2LM2_ZIM(-1))
C
-1.911048
0.298748
0.089075
0.305539
0.196963
0.041225
-6.254674
1.516771
2.160684
0.0000
0.1388
0.0381
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.744590
0.729110
0.231038
1.761499
3.230577
48.10195
0.000000
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
0.014218
0.443903
-0.012810
0.119150
0.033248
1.726003
Log(CPI_ZIM) is I(2)
Null Hypothesis: D2LCPI_ZIM has a unit root
Exogenous: None
Lag Length: 0 (Automatic - based on SIC, maxlag=9)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(D2LCPI_ZIM)
Method: Least Squares
Date: 01/31/13 Time: 10:56
Sample (adjusted): 1998Q4 2007Q4
Included observations: 37 after adjustments
t-Statistic
Prob.*
-8.282693
-2.628961
-1.950117
-1.611339
0.0000
Appendix I
41
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D2LCPI_ZIM(-1)
-1.859763
0.224536
-8.282693
0.0000
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
Durbin-Watson stat
0.652761
0.652761
0.264071
2.510406
-2.726965
1.379334
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
0.041822
0.448132
0.201458
0.244996
0.216807
Appendix I
42
Log(GDPRUS$_ZIM) is I(1)
Null Hypothesis: DLGDPRUS$_ZIM has a unit root
Exogenous: Constant
Lag Length: 1 (Automatic - based on SIC, maxlag=9)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-6.445926
-3.600987
-2.935001
-2.605836
0.0000
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(DLGDPRUS$_ZIM)
Method: Least Squares
Date: 01/31/13 Time: 11:04
Sample (adjusted): 1998Q4 2008Q4
Included observations: 41 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
DLGDPRUS$_ZIM(-1)
D(DLGDPRUS$_ZIM(-1))
C
-0.225780
0.980967
-0.003800
0.035027
0.084844
0.000819
-6.445926
11.56203
-4.640952
0.0000
0.0000
0.0000
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.786864
0.775646
0.003503
0.000466
175.2047
70.14503
0.000000
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
-0.001084
0.007395
-8.400230
-8.274847
-8.354573
1.341397
Appendix I
43
Log(CPI_USA) is I(1)
Null Hypothesis: D(LCPI_USA) has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=12)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-5.947728
-3.481217
-2.883753
-2.578694
0.0000
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(LCPI_USA,2)
Method: Least Squares
Date: 01/27/13 Time: 22:01
Sample (adjusted): 1998M03 2008M12
Included observations: 130 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D(LCPI_USA(-1))
C
-0.469971
0.000896
0.079017
0.000357
-5.947728
2.508590
0.0000
0.0134
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.216529
0.210408
0.003605
0.001663
547.8592
35.37547
0.000000
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
-9.22E-05
0.004057
-8.397834
-8.353718
-8.379909
1.884455
Appendix I
44
Log(M2_USA) is I(1)
Null Hypothesis: D(LM2_USA) has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=9)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-4.127530
-3.596616
-2.933158
-2.604867
0.0024
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(LM2_USA,2)
Method: Least Squares
Date: 02/04/13 Time: 13:47
Sample (adjusted): 1998Q3 2008Q4
Included observations: 42 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D(LM2_USA(-1))
C
-0.789836
0.012907
0.191358
0.003194
-4.127530
4.040516
0.0002
0.0002
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.298695
0.281162
0.007594
0.002307
146.4066
17.03651
0.000181
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
0.000641
0.008957
-6.876506
-6.793760
-6.846176
1.668355
Appendix I
45
Log(GDPR_USA) is I(1)
Null Hypothesis: D(LGDPR_USA) has a unit root
Exogenous: Constant
Lag Length: 0 (Automatic - based on SIC, maxlag=9)
Augmented Dickey-Fuller test statistic
Test critical values:
1% level
5% level
10% level
t-Statistic
Prob.*
-2.864212
-3.596616
-2.933158
-2.604867
0.0582
*MacKinnon (1996) one-sided p-values.
Augmented Dickey-Fuller Test Equation
Dependent Variable: D(LGDPR_USA,2)
Method: Least Squares
Date: 02/04/13 Time: 13:57
Sample (adjusted): 1998Q3 2008Q4
Included observations: 42 after adjustments
Variable
Coefficient
Std. Error
t-Statistic
Prob.
D(LGDPR_USA(-1))
C
-0.531107
0.002611
0.185428
0.001599
-2.864212
1.633255
0.0066
0.1103
R-squared
Adjusted R-squared
S.E. of regression
Sum squared resid
Log likelihood
F-statistic
Prob(F-statistic)
0.170188
0.149443
0.006995
0.001957
149.8575
8.203712
0.006628
Mean dependent var
S.D. dependent var
Akaike info criterion
Schwarz criterion
Hannan-Quinn criter.
Durbin-Watson stat
-0.000767
0.007585
-7.040835
-6.958089
-7.010505
2.011514
Appendix I
46
2. Granger Causality Tests
Pairwise Granger Causality Tests
Date: 01/31/13 Time: 13:49
Sample: 1998Q1 2008Q1
Lags: 4
Null Hypothesis:
Obs
F-Statistic
Prob.
D2LNER_OFF does not Granger Cause D2LCPI_ZIM
D2LCPI_ZIM does not Granger Cause D2LNER_OFF
35
2.07257
3.57034
0.1134
0.0189
D2LM2_ZIM does not Granger Cause D2LCPI_ZIM
D2LCPI_ZIM does not Granger Cause D2LM2_ZIM
35
10.7270
2.09417
3.E-05
0.1104
D2LNER_PAR does not Granger Cause D2LCPI_ZIM
D2LCPI_ZIM does not Granger Cause D2LNER_PAR
35
0.67742
0.37641
0.6138
0.8233
D2LM2_ZIM does not Granger Cause D2LNER_OFF
D2LNER_OFF does not Granger Cause D2LM2_ZIM
35
6.90481
0.71857
0.0006
0.5870
D2LNER_PAR does not Granger Cause D2LNER_OFF
D2LNER_OFF does not Granger Cause D2LNER_PAR
35
6.49061
2.00788
0.0009
0.1229
D2LNER_PAR does not Granger Cause D2LM2_ZIM
D2LM2_ZIM does not Granger Cause D2LNER_PAR
35
2.25719
2.09755
0.0903
0.1100
Appendix I
47
3. Cointegration Test for Quantity Theory of Money:
Johansen Test for a Cointegrating Equation
lcpi_zim_usa = log(cpi_zim/cpi_usa)
dlcpi_zim_usa = first difference of lcpi_zim_usa
lm2_zim_usa = log(m2_zim/m2_usa)
dlm2_zim_usa = first difference of lm2_zim_usa
lgdpr_zim_usa = log(gdprus$_zim/gdpr_usa)
dlgdpr_zim_usa = first difference of lgdpr_zim_usa
Date: 02/04/13 Time: 14:03
Sample: 1998Q1 2007Q4
Included observations: 37
Series: DLNER_PAR DLCPI_ZIM_USA
DLGDPR_ZIM_USA
Lags interval: 1 to 1
Selected (0.05 level*) Number of Cointegrating Relations by Model
Data Trend:
Test Type
Trace
Max-Eig
None
No Intercept
No Trend
1
1
None
Intercept
No Trend
1
1
Linear
Intercept
No Trend
1
1
Linear
Intercept
Trend
1
1
Quadratic
Intercept
Trend
1
1
*Critical values based on MacKinnon-Haug-Michelis (1999)
Information Criteria by Rank and Model
Data Trend:
Rank or
No. of CEs
0
1
2
3
0
1
2
3
0
1
2
3
None
No Intercept
No Trend
None
Intercept
No Trend
Linear
Intercept
No Trend
Linear
Intercept
Trend
Quadratic
Intercept
Trend
Log Likelihood by Rank (rows) and Model (columns)
104.9985
104.9985
107.1517
107.1517
130.5715
139.2083
140.4643
140.4675
132.1355
142.3220
143.2687
144.0126
132.6677
143.8724
143.8724
146.0497
110.4992
142.5928
145.6647
146.0497
Akaike Information Criteria by Rank (rows) and Model (columns)
-5.189108
-5.189108
-5.143335
-5.143335
-5.162119
-6.247107
-6.659910*
-6.619694
-6.565812
-6.572583
-6.007327
-6.449838
-6.446956
-6.379060
-6.414310
-5.711767
-6.155266
-6.155266
-6.110796
-6.110796
Schwarz Criteria by Rank (rows) and Model (columns)
-4.797263
-4.797263
-4.620875
-4.620875
-5.594032
-5.963297*
-5.836004
-5.738583
-5.093022
-5.448457
-5.402036
-5.247063
-4.536233
-4.849116
-4.849116
-4.674032
-4.509044
-5.658278
-5.238775
-4.674032
Appendix I
4.
48
Estimate of Vector Error Correction Model For Quantity Theory of Money
Vector Error Correction Estimates
Date: 02/04/13 Time: 14:38
Sample (adjusted): 1998Q4 2007Q4
Included observations: 37 after adjustments
Standard errors in ( ) & t-statistics in [ ]
Cointegrating Eq:
CointEq1
DLNER_PAR(-1)
1.000000
DLM2_ZIM_USA(-1)
-0.893439
(0.06305)
[-14.1693]
DLGDPR_ZIM_USA(-1)
-3.401794
(1.54986)
[-2.19491]
C
-0.150582
(0.04894)
[-3.07690]
Error Correction:
D(DLNER_PAR D(DLM2_ZIM_U D(DLGDPR_ZI
)
SA)
M_USA)
CointEq1
-1.052874
(0.39181)
[-2.68722]
0.317037
(0.22410)
[ 1.41470]
-0.005102
(0.00921)
[-0.55387]
D(DLNER_PAR(-1))
0.284449
(0.26794)
[ 1.06163]
-0.101330
(0.15325)
[-0.66120]
0.009493
(0.00630)
[ 1.50707]
D(DLM2_ZIM_USA(-1))
-0.699463
(0.37701)
[-1.85530]
-0.498006
(0.21564)
[-2.30946]
-0.015010
(0.00886)
[-1.69360]
D(DLGDPR_ZIM_USA(-1))
-2.202120
(7.60711)
[-0.28948]
2.355977
(4.35104)
[ 0.54147]
0.030305
(0.17883)
[ 0.16946]
R-squared
Adj. R-squared
Sum sq. resids
S.E. equation
F-statistic
Log likelihood
Akaike AIC
Schwarz SC
Mean dependent
S.D. dependent
0.341867
0.282036
5.883166
0.422230
5.713939
-18.48250
1.215270
1.389424
0.039940
0.498307
0.216358
0.145118
1.924678
0.241503
3.037027
2.188223
0.097934
0.272087
0.050246
0.261197
0.092108
0.009572
0.003251
0.009926
1.115973
120.2820
-6.285515
-6.111362
-0.000463
0.009974
Determinant resid covariance (dof adj.)
Determinant resid covariance
Log likelihood
Akaike information criterion
Schwarz criterion
2.65E-07
1.88E-07
129.0119
-6.108750
-5.412137
Appendix II
49
Appendix II: Data
1. USA data on money and prices from IMF, International Financial Statistics
CPI: Obtained from the Bureau of Labour Statistics, Consumer Price Index – All Urban
Consumers (US City Average), Series ID: CUUR0000SA0 (1998 – 2008), monthly data
M2 money supply: Obtained from the International Monetary Fund’s International Financial
Statistics database. (1998 -2008), monthly data
Real gross domestic product: Obtained from the International Monetary Fund’s International
Financial Statistics database. (1998 -2008), quarterly data
2. Zimbabwe data:
Reserve money and RBZ balance sheet: from RBZ
Broad money supply and monetary survey: IMF
Consumer Price Index: Monthly data from Zim Stat, IMF, and John Robertson for
hyperinflation period.
Real GDP: Annual data provided by Zim Stat, national statistical agency.
Parallel market Rate: Obtained from the Reserve Bank of Zimbabwe (1998 – 2008), monthly
data
Official exchange rate: Obtained from the Reserve Bank of Zimbabwe (1998 – 2008),
monthly data
3. World Bank development indicators: The dataset is accessible at
http://data.worldbank.org/data-catalog/world-development-indicators
4. Exchange Control data
Chin-ITO index: Dataset of financial openness can be accessed at:
http://web.pdx.edu/~ito/Chinn-Ito_website.htm
Ellyne, Mark and Emmanuel Letete (2012), Exchange Control Liberalization in SADC and Its
Implications for Monetary Union, Mimeo.
Chater, Rachel and Mark Ellyne (2013), Exchange Controls in the Context of SADC Regional
Integration: A New Index for Measuring SADC Restrictiveness, Mimeo
Appendix II
50
Hanke & Krus(2012) table of all known cases of hyperinflation