Will current price stability continue?
BOTH the official exchange rate as determined by the forex auction market and the unofficial markets are more or less stable. Likewise the prices of goods and services are not rising at alarming rates. Does this semblance of stability of prices indicate that our economy has turned the corner, signalling that our economy is on the mend?
We need to study how the key influencers shape governments’ policies on economic matters. The two dominant views are from the British mathematician-turned-economist John Maynard Keynes and the American economist Milton Friedman.
Keynes’ thoughts are packaged under the name Keynesianism. This package of ideas is also known as fiscalism. Friedman’s ideas are known as monetarism. Both men’s ideas have a large influence on how our current Treasury and the reserve bank think and shape economic strategies.
We begin with Friedman’s view of how the economy works. He suggested that governments or central banks should always maintain a steady growth of money supply each year to bring certainty to producers. The argument is that if producers know that each year the government or central bank will increase money supply by a predictable quantum, the producers can adjust their production in tandem. This upward adjustment in the production of goods and services is said to result in a steady growth of the economy and the development of minimal inflation (price stability). Friedman argued that when the quantity of goods and services increases, prices will remain relatively constant. Friedman is about a steady economic growth rate policy driven by predictable minimal increase in money supply as a cue for producers to adjust production upwards.
How do adherents of Keynes’s ideas view things economically? Keynesians argue that the driver of economic growth (increase in production of goods and services) is an increase in aggregate demand (meaning the entire population wants to consume more and more goods and services). The question then is how do Keynesians ensure the population keeps wanting to consume more and more goods and services? Their strategy is simply this: The government has to get more money into the hands of the people by increasing money supply. Monetarists are quick to caution that the money supply should be minimal and predictable or inflation will increase (price instability).
Monetarists argue that this increase in prices (inflation) will not be compensated by an increase in goods and services, meaning that there is no real growth in the economy. For monetarists, production increases before money supply increases — producers have the confidence that monetary authorities will responsibly increase money supply. Producers increase investment and create more employment — the increase in expected profits will result in better wages — hence increase in aggregate demand.
To what extent have the ideas of Friedman and Keynes had an influence in the stabilisation of prices in Zimbabwe over the past months.
Friedman’s ideas are being heavily leased by the Monetary Policy Committee (MPC). Their key policy tool is reserve money targeting. Reserve money is money directly under the control of the central bank. The thinking is that if the central bank keeps reserve money under check, it can contribute towards controlling the growth of broad money supply (mainly through credit creation by banks). The central bank has a clear money supply growth target.
In order to build trust in the central bank’s policy implementation, the central bank has been publishing weekly updates of money supply targets. To remove pressure from the central bank, Treasury has committed to keeping budget deficits very low and in addition Treasury has said it will not go to the central bank to borrow from it to meet government’s expenditure shortfalls.
It is clear that the Treasury is committed to a Friedman way of doing things. Clearly, the central bank and Treasury share the same economic ideology. That is a great development. It boosts confidence that there will be policy consistency and policy harmony insofar as monetary policy and fiscal policy are concerned. The control of mobile money transactions was designed to ensure that money supply growth cannot happen outside the control of monetary authorities.
The question that arises is: Is this money supply control responsible for the current price stability? Money supply growth is being successfully controlled but the economy has not been growing. In fact, we have experienced a recession for two consecutive years. There has been a real decline in the economy for two consecutive years — meaning the amount of goods and services produced has been declining for two consecutive years. The greatest decline has been shown by a huge drop in expenditures by households.
Clearly, the effects of Covid-19, droughts of of 2019 and 2020, lack of foreign direct investment as a result of a poor perception of Zimbabwe as a safe destination of investment, lack of entrepreneurship in the key sector of agriculture due to a lack of security of tenure and non-market selection of players in the commercial agriculture sector have depressed production.
So clearly, with money supply under control, we find ourselves with a classic Keynesian problem — we do not have sufficient aggregate demand. So we have stable prices of goods and services that cannot be afforded by large sections of the population.
The official-partial dollarisation system we are under is also responsible for stable, but elevated prices. We do not have the evidence yet that the central bank’s money supply growth control has translated into giving producers the confidence to make sustained investments and create more jobs — the current indicators on the ground point to job losses and low private sector investment. Monetarism has not yet started to work the way monetarists expect it — monetarists expected price stability to engender increase in investments and a reduction of unemployment.
The year 2021 will be the ultimate test for monetarism. Good rains and a fairly better preparation for the cropping season (marred by heavy shortage of fertilisers) should contribute towards real growth (minimal) of the economy with incomes from the increased production in agriculture lifting aggregate demand. Under those conditions, we should be able to determine if the money supply growth targets are deep enough to absorb the expected increase in aggregate demand fuelled by increase in incomes from agriculture — inflation should keep declining, not rising.