Bastiat’s Bastions

Zimbabwe, a former British colony in southern Africa, is experiencing economic and social collapse. With a government which has cannot collect enough taxes to cover its insatiable spending habits. Failing to bring in enough in taxes to pay for spending, the government turns to its central bank and has it print the money that the government wishes to spend. The head of Zimbabwe’s central bank admits massive printing of money but refuses to slow down the money growth.

With money in the system growing faster than production, goods and services (from here on, let’s just lump goods and services together and use the word “goods” for both goods and services) become scarcer relative to the money in the system and prices of goods reflect that increasing relative scarcity by their prices rising terms of the money that it takes to buy those goods. Not only have the official inflation rates soared well over 3200% per year, but there is reason to believe that using CPI measures, that the inflation in Zimbabwe is understated, especially since many of the items used in the CPI are price controlled commodities. A truer measure of the inflation rate is by looking at black market exchange rates.

After a few definitions, we will look at one thing that we know, with absolute certainty in macroeconomics, about the connection between the money supply and inflation. Let’s define:

m as the annual growth rate in the money supply, whether cash or checking money, in percent;

v as the annual growth rate in the speed at which money changes hands, or the acceleration of money (or the reduction in the time that people hang on to the average dollar before spending it), also in percent;

p as the annual growth rate in prices or the inflation rate as measured by the GDP deflator, also in percent;

q as the growth in real production or in Real GDP, also in percent.

Here is what we know for sure, because of definitions of the terms:

m + v ≡ p + q, or p ≡ m + v – q, so that inflation must equal the growth in the money supply plus the acceleration of money through the economic system minus the growth of real production. With lower levels of inflation, the rate of spending of dollars is pretty steady, so v = 0. Then, inflation is mostly explained by the difference in the growth rate in the money supply, either from money printing or from banks expanding loans and creating new checking money, and the growth rate of the economy.

As inflation approaches the levels we see in Zimbabwe, v gets larger, as money starts to “burn holes” in peoples’ pockets because it is losing its value so rapidly. The faster money is losing its value because of inflation, the less people will want to hang onto it, because many goods will keep their values better than money. This adds fuel to the inflationary fire.

In addition, people on longer-term pay contracts will try to renegotiate their pay. This is what is happening with the Zimbabwean medical community where nurses cannot afford the price of the transportation to work.

One response to inflation is to slap on wage and price controls. President Mugabe has signed into law such price controls with stiff penalties for violators. The country has some severe shortages due to the inflation, and now, due to the wage and price controls. It is so hard to get fuel and fertilizer that only 10% of the usual winter wheat crop has been planted. The price controls will lead to further shortages, which mean lower levels of production, or reductions in the growth rate of Real GDP, or q, which again, lead to higher degrees of inflation.

Still, Zimbabwe’s leaders blame everybody but themselves for their hyperinflation and collapsing economy. As they are in total control of the money supply, no one else can be blamed. However, Zimbabwe is not a very well educated country. Even in a country as highly educated as the U.S. many voters still probably don’t understand that the central bank has complete power over inflation. Government officials blame everyone else, especially foreigners, though, to stay in power.

Here is an excellent article on the causes and consequences of inflation discussing inflation in both historical terms and giving an overview of monetarist and nonmonetarist positions of inflation. It was penned by David Ranson, president of HC Wainwright and Company, Economics, an investment research firm in Boston. He was formerly an assistant to the secretary of the Treasury in Washington.

-MC