In April 2009, the African nation of Zimbabwe suspended the use of its own curre
ID: 1191477 • Letter: I
Question
In April 2009, the African nation of Zimbabwe suspended the use of its own currency, the Zimbabwean dollar. According to an article from the Voice of America, "Hyperinflation in 2007 and 2008 made Zimbabwe's currencyvirtually worthless despite the introduction of bigger and bigger notes, including a 10 trillion dollar bill." Zimbabwe's Economic Planning Minister, Elton Mangoma, was quoted as saying the Zimbabwean dollar "will be out for at least a year," and in January 2009, the government of Zimbabwe made the US dollar the country's official currency.
[a] Based on the analysis of Chapter 11, what was the probable cause of Zimbabwe's hyperinflation?
[b] Why would making the US dollar the official currency enable Zimbabwe to end the hyperinflation?
Explanation / Answer
A) In economics, inflation refers to a phenomenon where prices increase over a period of time.
Hyperinflation occurs when prices increase at a very abnormal rate. In case of Zimbabwe, it was observed that the annualized inflation rates touched an astonishing rate of 8 billion percent in 2008. Fortunately, those levels of hyperinflation did not last too long! Such hyperinflation rates forced Zimbabwean government to release currency of the highest denomination ever – a trillion dollar note. The hyperinflation rates have forced the government to abandon the local currency and adopt the US dollar as the local currency.
The probable causes of hyperinflation may include the following:
1) A very high level of government debt – this might sometimes be more than 100% of a nation’s gross domestic product
2) To counter the effects of large levels of debts, governments usually tend to print more currency which eventually decreases the value of the local currency. This leads to lower confidence of people in the value of their currency thereby demanding higher salaries
3) It could also be the inability of the government to understand the situation and take appropriate action to remedy the situation
Hyperinflation ultimately lowers the confidence of the people in the economy and drastically affects the quality of living standards of the people.
B) Changing the currency from Zimbabwean dollar to US dollar helped Zimbabwe to arrest the hyperinflation levels and save the economy from the brink of collapse. This change also helps people from carrying the burden of carrying the local currency in big bags or wheelbarrows to buy their daily needs. The currency changeover has also helped Zimbabwe to pass the control over its economy to USA rather than suffer due to the policies of the local government. Subsequently, the present money supply in Zimbabwe is dependent on the policies of US Treasury department. The change in currency can also be seen as an attempt by the local government to win back the confidence of its people.
Benefits of adopting US dollar
1) The dollarization policy of Zimbabwe will help the country to eliminate hyperinflation and restore economic stability.
2) It will also help the government to exercise better budgetary discipline and revive the credibility of the monetary system of the country.
3) The new currency system will also help in stabilizing the formal banking system in the country. Foreign banks will be encouraged to do business in Zimbabwe thereby improving the overall liquidity position in the country.
4) The price distortions in goods and foreign exchange markets have been reduced
5) In a stable financial system, people gain more confidence to save their earnings
6) The lending rates are likely to come down from abnormally high rates to manageable levels thereby increasing the spending power of the population. This is likely to positively impact the overall economic growth of Zimbabwe in the near future.