Saturday, March 28, 2009

Zimbabwe Defeats Hyperinflation

The Globe and Mail wrote an article on How Zimbabwe slew the dragon of hyperinflation and it warrants looking at some of the key features of this story.

When a country's currency is in trouble (hyper-inflation) most traditional fiscal and monetary policy remedies won't work. There are several rather extreme options to deal with the problem:
  • Issuing a new currency
  • Adopting foreign currency
Now in either of these cases, you are forced to abandon your previous currency (obviously). However, issuing your own new currency tends not to help in the case of Zimbabwe as it is implied that they would have run into the same problems again. Following this option would have required an overhaul of the financial system there along with the replacement of key government officials and policies to instill confidence in the new currency (you can't just label a lemon an orange and try to sell it again).

However, that method is slow as it requires the people who hold the new currency to have faith in the government that controls it. Instead, Zimbabwe opted to switch to foreign currencies: US dollar, South African rand and Botswana pula. What's the downside of this option? No control on monetary policy (which works as both a plus and minus). This means that the government has no control over the currency (which for some people is a good thing in this case).

Loss of a currency is a serious issue. For instance, I would be interested in seeing what a Zimbabwe "federal budget" would look like.

Also, on the ground level, there isn't much "change" as the article states, as shop keepers don't have enough to coins and small denominations to make change and they will issue notes or ask customers to take change in the form of candies or small trinket products. This is indicative of the hiccups in the money flow and must have a negative effect on the velocity of money (and GDP).

Although this is a major step in trying to set things right, there is plenty more work to be done.

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