Monetary policy in a complex economy

“MAINSTREAM neoclassical economics, which has been the dominant economic thinking for over a century, is no longer an adequate mental model to interpret and shape the socio-economics of a new reality. Conventional neo-classical theory no longer reflects realities because in the real world, economies are not static and geared towards equilibrium; they are dynamic and in constant flux with constant unpredictability.

“This dynamism is endogenous; it originates within the system, not from exogenous shocks. In reality, the economy is a complex ecology rather than a complicated machine whose parts can be analysed and understood. It does not respond in predictable ways rather, it is path-dependent, with each phase building on the previous one. This is a more realistic understanding of the way economic systems develop and change especially in this fast pace information age.”

(This is according to a paper published by the Institute for Public Policy Research (IPPR) titled: “A Complex New World: Translating new economic thinking into public policy”.)

In my opinion, this certainly applies to the Zimbabwean economy where we now have a predominantly informal economy which is unregulated and contributes an estimated 70% to GDP. This economy also prices the US$ exchange rate on its own terms, divorced from formal monetary policy, economic fundamentals and policymaker assumptions and expectations.

As I have stated before, it is, indeed, an unenviable challenge to have to manage what has become a highly speculative monetary sector where there is perennial speculative profitseeking at the expense of productive endeavours.

In my opinion, the Reserve Bank of Zimbabwe governor John Mangundya faces a formidable task each day to try and manage money supply and suppress inflation in an economy where the perception of value is in a currency other than ours and where formal interventions have limited impact.

An economy where behavioural economics, which is mostly misunderstood, dominates.

It is, indeed, true as the governor recently acknowledged that as an economy we cannot wish the parallel market away, but it must not be allowed to be the key determining factor on the general level of prices because, if that becomes the norm, everyone loses out.

The irony of it all is that, through ubiquitous speculation, we are inadvertently creating a self-reinforcing loop where US$ exchange rates increase, leading to price increases which further fuels inflation, which results in a further increase in US$ rates and so on. The governor’s task must be quite frustrating, indeed, as we seemingly chase our own tail.

We must acknowledge that our economy has become “non-linear, dynamic and involves continuous adaptation to patterns the economic system itself creates” and under such an environment, economic policy can often be rendered sterile by behavioural and not fundamental issues.

The political economy of US$ rates and inflation is rather complex and involves many ever-changing variables which include how cash-rich businesses behave, general public (especially informal sector) confidence and psychology, effectiveness of monetary policy measures, foreign exchange inflows, imported inflation and political developments. Each of these plays some part in determining what the US$ rate becomes.

The positive news, as reported by the RBZ last week, is that the inflows of US$ into the country continue to increase and this requires that we allocate it as much as possible to productive purposes. There is no doubt that auction is certainly assisting in ensuring this, where bids which are not on the priority list are rejected.

However, the disbursement of auction funds needs to improve so that there is no outstanding pipeline before the next auction happens. Added to this is the need to ensure that the funds, once acquired, are not abused by speculators in the business sector.

However, an interesting phenomenon which policymakers need to acknowledge is that, funny enough, an increase in the supply of US$ in the market does not necessarily lead to the price of the US$ decreasing, as would be expected in demand and supply neoclassical theory. Instead, the price can actually increase due to the search for a store of value by holders of the local currency, who are prepared to pay more. Consequently, bidders will pay more for the US$ because of the inherent psychology of value perception in the US$ which has an insatiable demand. In short, an increase in US$ supply leads to its price increase which further fuels inflationary pressures, much against theoretical expectations of its price to actually decrease due to increased supply. This is what I have termed: “The paradox of increasing USD rates in Zimbabwe”.

World over, central banks have to intervene in order to stabilise currencies because it can cause systemic economic shocks and the RBZ has pledged to utilise about US$500 million of the recently received Special Drawing Rights of US$961 million from IMF to support the local currency.

Whether we shall see rates going down is another issue. What this may achieve is to slow down US$ rate increase.

In my opinion, a managed exchange rate which acknowledges the existence of the parallel market would be more ideal. A “blended rate” for the purposes of business transactions could then be allowable. The issue remains discipline, ethics and unity of purpose among banks, the business sector and policymakers.

They are some quarters which are calling for a free market approach to the US$ rate in the belief that it will find its real price. Theoretically that sounds attractive but the unintended consequences of such a move in a highly informal, inefficient and speculative economy can actually cause economic collapse and lead us back to hyperinflation.

As long as we have a multiple currency regime, these problems will persist causing problems with business planning, investments and savings. At some time in the future, we just have to have our own stable currency in which citizens have confidence in, but this can only happen when the nightmare of 2008 is finally exorcised from the brains of the living. As claimed by Leon Louw in the book- When money Destroys Nations: “Zimbabwe’s hyperinflation was much more devastating than its liberation war or the oppression from which it liberated them”’’…. and to this day we still suffer from it.

What will it take to have own stable currency in which citizens have confidence in?

● Deficit spending and money printing is the source of all economic ruin. High government spending fuelled by borrowing and money printing are two evils which perpetuate economic ruin. This is made worse when that expenditure is consumptive.

● Confidence must be created through government policies which support and invest in economic growth. This requires leadership and institutional integrity and demonstrable competency and accountability.

● The productive capacity of the economy must increase and create real value, incomes and this requires high investment levels in productive assets, increased productivity and human capital development.

● Financial services sector must be well-regulated and managed. Speculative financial transactions must be exposed and dealt with decisively.

● Financial crimes and corruption must be exposed and prosecuted so that it becomes costly to take risks.

● Political legitimacy and stability underpinned by constitutionalism and democratic architecture and values is the foundation of economic prosperity and growth.

Citizens must be confident of a government which respects their rights, cares for their needs, is accountable and delivers.

Simple as it may sound, it is certainly not easy and yet, in order for things to get better they must surely change.