MIDLANDS STATE UNIVERSITY
FACULTY OF COMMERCE
DEPARTMENT OF ECONOMICS
PROGRAMME: B. COMM. ECONOMICS HONOURS DEGREE
MODULE: ECONOMETRICS B (EC409)
Determinants of money demand in Zimbabwe from 1980-2008
TABLE OF CONTENT
RESULTS PRESENTATION AND INTERPRETATION
POLICY RECOMMENDATION AND CONCLUSIONS
CHAPTER 1: INTRODUCTION
Since 2001 Zimbabwe has experienced rates of inflation above 100% annually, since 2006 this rose over 1,500% annually. Using a newly created price series we show that in September 2006 monthly inflation exceeded 50% per month entering an extended period of hyperinflation, as defined by Cagan (1956). Currently Zimbabwe is the only country with a hyper inflated economy and is the first case of hyperinflation as yet recorded in the 21st century. The authorities in Zimbabwe view the recent high inflation period through two prisms. First that private sector price speculation is driving the inflation. This tense atmosphere severely affected the demand for money in Zimbabwe.
The authorities maintain that the private sector bids up prices speculatively in order to maximize profits and exert extreme pressure on the economy through these large prices increases.`Speculation has surfaced at an alarming pace in virtually all sectors of the economy, with the demand for cash in the economy rising at astronomical rates, as people are positioning themselves to take advantage of rent-seeking opportunities.' RBZ (2006)
Second authorities in Zimbabwe maintain that negative aid shocks and international sanctions have contributed to the economic decline since 2000, including the high inflation rate. Zimbabwe has experienced development assistance and external financing shocks as access to International Finance Institution (IFI), European Union and others; assistance has been withheld from the country. This explanation suggests that printing money is one way the authorities have sought to finance the gap between expected government revenue (including grants and aid) and actual receipts. Money creation yields seigniorage revenue for monetary authorities in all economies. However increasing seigniorage, by increasing money creation, is associated with increased price levels if the domestic economy is unable to absorb the excess money supply. Over the past 4 years the Central Bank has maintained that the declared and undeclared sanctions are one of the main hindrances to our collective efforts to turning around the economy.' RBZ (2008). This paper seeks to examine these explanations in more depth.
1.1 BACKGROUND OF THE STUDY
A common theme in many theoretical macroeconomic models is an aggregate money demand function that links real balances, a measure of real income or transactions activity, and a short-term interest rate or other measure of the opportunity cost of holding real balances. In the conventional money demand function, real income represents the increasing demand for money as a producer’s and consumer’s good, by way of an income effect, as income rises. This is sometimes referred to as “transactions demand”. The interest rate term represents the interest elasticity of both the transactions demand for money and the speculative demand through Tobin’s portfolio balance model, and may represent a potential substitutability against bonds in production and consumption decisions (Bran on (1989, p.343)). As pointed out by Hoffman et al. (1995), a stable long-run money demand function is a central proposition to monetarist models, New Classical monetary models, and even some New Keynesian models and real business cycle models that incorporate inflation and the general price level. Empirically, however, the literature on long-run money demand equations has documented periods of “missing money”....
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