Zimbabwe:
A Quest for a Nominal Anchor
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Arto Kovanen
© 2004 International Monetary Fund WP/04/130
IMF Working Paper
African Department
Zimbabwe: A Quest for a Nominal Anchor
Prepared by Arto Kovanen
1
Authorized for distribution by Hugh Bredenkamp
July 2004
Abstract
This Working Paper should not be reported as representing the
views of the IMF.
The views expressed in this Working Paper are those of the
author(s) and do not necessarily represent
those of the IMF or IMF policy. Working Papers describe research
in progress by the author(s) and are
published to elicit comments and to further
debate.
This study examines the appropriateness of alternative
intermediate monetary policy targets
for Zimbabwe in light of the stability of the demand for money and
the information content
of financial variables for predicting price level movements.
Results of the study indicate that
a well-defined long-run demand relation exists for currency in
circulation, but not for other
monetary aggregates. Currency in circulation has strong
information content for predicting
future price level movements. The information content of other
financial variables, such as
the exchange rate and interest rates, is weaker. Statistical
relationships break down of the
outset of high inflation.
JEL Classification Numbers: E31, E41, E61
Keywords: Monetary policy, demand for money, nominal anchors, and
inflation
Author
’s E-Mail Address: Akovanen@imf.org
1
The author thanks
Vivek Arora, Ashok Bhundia, Rodolphe Blavy, Hugh Bredenkamp,
Paul Cashin, David T. Coe, Louis Erasmus, G. G. Johnson,
Jean-Claude Nachega,
Obert Nyawata, Luca Ricci, Doris Ross, Ratna Sahay, and Matthias
Vocke for their comments.
He is also grateful to Thomas Walter for editorial assistance. The
usual disclaimer applies.
- 2 -
Contents Page
I. Background
....................................................................................................................4
II.
Data...............................................................................................................................6
III. Information Content of Financial Variables
..................................................................7
IV. A Quest for a Nominal
Anchor......................................................................................9
A. Full-Sample Estimates
.......................................................................................11
B. Estimates for the Subperiod 1980: 1–1995: 12
..................................................13
V.
Conclusions..................................................................................................................14
Appendix
I. Definition of Data
Variables..............................................................................................38
References...............................................................................................................................39
Box
1. Summary of Results for Selected Studies of Long Run
Money Demand for
Zimbabwe.......................................................................................16
Tables
1. Selected Features of Inflation, 1980: 1-2003: 12
...............................................................17
2. Summary Statistics 1980: 1-2001:12
..................................................................................18
3. Unit-Root Tests, 1980: 1-2001:12
......................................................................................19
4. Biviariate Granger-Causality
Tests.....................................................................................20
5a. Multivariate Granger-Causality Tests, 1980: 1-2001:12
..................................................21
5b. Multivariate Granger-Causality Tests, 1980: 1-1995:12
...................................................21
5c. Multivariate Granger-Causality Tests, 1996: 1-2001:12
...................................................21
6. Variance
Decomposition....................................................................................................22
7. Unrestricted Cointegration Estimates for Currency in
Circulation 1980:1–2001:12 ........23
8a. Currency in Circulation: Test for Normality of the Residuals,
1980:1-2001:12 ..............24
8b. Residual Correlation Matrix,
1980:1-2001:12..................................................................25
9. Pairwise Granger Causality/Block Exongeneity Wald Tests,
1980:1-2001:12................26
10. Unrestricted Cointegration Estimates for Currency in
Circulation, 1980:1-1995:12 .......27
11a. Currency in Circulation: Test for Normality of the Residuals,
1980:1-1995:12 .............28
11b. Residual Correlation Matrix,
1980:1-1995:12.................................................................29
12. Pairwise Granger Causality/Block Exogeniety Wald Tests, 1980:
1-1995:12................30
- 3 -
Contents Page
Figures
1. Consumer Price Inflation,
1980:1-2003:12.........................................................................31
2. Inflation and Output Growth,
1981–2002...........................................................................32
3. Financial Intermediation and Interest Rates, 1980-2002
....................................................33
4. Treasury Bill and Three-Month Bank Deposit Interest Rates,
1980:1–2003:10 ................34
5. Real GDP and Manufacturing Output,
1975–2002.............................................................35
6. Residuals from VAR, 1980: 1-2001:12
..............................................................................36
7. Responses of Inflation to Innovation
..................................................................................37
- 4 -
I. B
ACKGROUND
Zimbabwe is in the midst of its worst economic downturn since it
achieved independence in
1980. Real output has fallen by one-third since 1999. Unemployment
has risen sharply and
has become pervasive and widespread. Social conditions are eroding
rapidly, owing to weak
economic policies and mismanagement.
2 Public services are
stretched to their limits, in part
reflecting the high incidence of HIV/AIDS, resource constraints,
and emigration. Economic
hardships have taken a huge toll on the population, with the poor
suffering the most.
Consumer price inflation in Zimbabwe has risen steadily during the
past two decades
(Table 1 and Figure 1). The volatility of inflation, measured by
the standard deviation of
annual inflation, has risen considerably, in particular during
2000-2003 when inflation
accelerated. Movements in the exchange rate have coincided with
changes in the price level,
suggesting that the exchange rate adjusted for inflation may have
been broadly appropriate in
the past, except for the period 1999 when movements in the
official exchange rate have not
kept pace with the rise in inflation.
3 Inflation has moved
inversely to output growth (Figure
2).
High inflation distorts resource allocation and complicates
economic management. Further, it
undermines incentives for productive investment and reduces
productivity growth. Research
points out that high inflation exerts a disproportionate effect on
the welfare of the poor (see,
for example, Easterly and Fischer, 2001). Large fiscal deficits
and foreign exchange market
distortions, which are often causes of inflation, adversely impact
real growth (Fischer, 1993).
Because of these adverse effects of high inflation on economic
development, macroeconomic
policies are best geared toward maintaining low inflation. Across
the world, as a result of
policies aimed at lowering inflation, inflation has displayed a
declining trend since the mid-
1990s, for both developing and industrial countries. Among African
countries, annual
average inflation has fallen to about 10 percent in
2003.
4
The authorities in Zimbabwe have experimented with several
monetary policy frameworks to
contain inflation, including exchange rate and monetary-based
anchors, but these attempts
did not achieve credibility owing to fiscal dominance. For
example, the government granted
2
Zimbabwe
experienced severe droughts in 2001-2003, which added to the economic
problems and required large-scale food imports by the government
and donors to supplement
the local crops.
3
However, the
instantaneous correlation between the official exchange rate and prices
is
rather low, about 33 percent in the full sample. Furthermore,
comovements in the exchange
rate and the price level should not be interpreted as suggesting
causality between these
variables
4
Table 8, IMF
World Economic Outlook,
September
2003.
- 5 -
large pension increases for war veterans in 1997 that were
unbudgeted, thereby contributing
an important way to the exchange crisis that followed. In 1999,
the authorities fixed the
official exchange rate. Because official reserves were low and the
exchange rate policy was
not supported by other macroeconomic policies, particularly fiscal
policy, it failed to provide
a credible nominal anchor for the economy. As a result, the real
exchange rate appreciated
rapidly and a significant parallel exchange market emerged.
Foreign exchange shortages in
the official market forced the authorities to devalue the official
exchange rate in August
2001, with an announced policy of adjusting the exchange rate in
line with actual inflation.
However, after a few months, the authorities abandoned the
crawling–peg exchange rate
regime and kept the exchange rate unchanged until February 2003,
when the exchange rate
was devalued for most external transactions. In the meantime, the
parallel market exchange
rate depreciated rapidly.
Financial markets in Zimbabwe have undergone significant changes
during the past two
decades, particularly following the financial liberalization of
the early 1990s, which
increased financial intermediation, as evidenced by the rise in
the ratio of bank deposits to
currency (Figure 3). An important factor behind financial
deepening was the liberalization of
bank interest rates in the early 1990s, which increased the
attractiveness of interest-bearing
deposits by providing positive real return.
5 However, the failure
to contain fiscal deficits after
that led to an explosion of fiscal financing needs in the late
1990s, which were met, to a large
extent, from domestic sources. This crowded out private sector
credit and resulted in high
real interest rates, while investors shifted away from bank
deposits-to-treasury bills as the
spread between deposit rates and treasury bill yields widened
(Figure 4). In response to high
nominal and real treasury bill rates, the government restructured
its domestic public debt in
January 2001, which led to a collapse of interest rates. Real
interest rates became highly
negative and demand for currency and foreign exchange increased,
which contributed to
inflation. In these circumstances, monetary policy became
powerless to offset increases in
inflation pressures, and the Reserve Bank of Zimbabwe had no
policy autonomy in setting
interest rates.
6
Research on inflation and its determinants in Zimbabwe has been
limited. Odedokun (1997),
using pooled annual data for 32 sub-Saharan African countries,
including Zimbabwe, finds
that currency depreciation in the official and parallel markets,
monetary growth, and foreign
inflation have had significant impacts on domestic inflation.
Jenkins (1999) and Nyawata
(2001) examine the demand for money in Zimbabwe using quarterly
data and establish longrun
relations between money and the price level for currency, bank
deposits, and narrow and
5
The number of
financial institutions also grew as indigenous players entered the
financial
market.
6
See the discussion
about the relationship between fiscal deficits and inflation
in
International Monetary Fund
,
World Economic Outlook, May 2002.
- 6 -
broad moneys (see Box 1).
7
The existence of this type of relationship is
essential for a
successful money-based stabilization.
This study builds on the earlier research. It examines the
dynamics of inflation in Zimbabwe
and its determinants, as well as its implications for the conduct
of monetary policy. The study
uses a broad set of econometric techniques to analyze the monetary
transmission process in
Zimbabwe. Monthly data spanning 22 years is utilized. The paper is
structured as follows.
Section II discusses data issues. Section III analyzes the causal
relationship between the
price level and financial market variables using bi- and
multivariate Granger-causality tests.
(Variables are explained in the appendix.) In this section, a
vector-autoregressive (VAR)
model is estimated that will explain to what extent fluctuations
in the price level can be
explained by its own variance and to what extent they are caused
by the variance of other
variables. Section IV moves the discussion to the long-run
relationship between the price
level and financial variables. In order to consider the anchor
role of financial variables, one
needs to establish whether there is a well-identified relationship
between the variables
included in the analysis. The presence of cointegration between
the price and financial
variables would suggest that a monetary variable is “anchoring”
price expectations. This
study estimates long-run money-demand relations for currency in
circulation and reserve,
narrow, and broad money aggregates. Section V concludes and
discusses the implications of
the results for monetary policy implementation in
Zimbabwe.
II. D
ATA
The empirical analysis is based on monthly data for the period
1980:1-2001:12, including the
early years of the most recent economic downturn. In view of the
data limitations regarding,
in particular, real GDP, which is available annually, monthly GDP
data has been generated
by utilizing the seasonal pattern of the monthly manufacturing
data. Although manufacturing
output only represents about 20-25 percent of total output in
Zimbabwe, it correlates highly
with real GDP at the annual level and therefore appears
appropriate (Figure 5).
8 We use four
different definitions of money: currency in circulation, reserve,
narrow, and broad money
aggregates, and two interest rates (3-month treasury bill rate and
3-month time deposit
interest rate). The latter performs better in econometric tests
but the two move closely (see
Figure 4).
7
Jenkins (1999)
offers a well-written and detailed analysis of the financial developments
in
Zimbabwe from 1976 until 1996 and discusses the use of various
variables in estimating the
money demand function for Zimbabwe.
8
The correlation
between the annual growth rates of manufacturing and real GDP is 0.77.
In
addition, manufacturing production is to a large extent dependent
on agricultural production,
a key economic sector in Zimbabwe, as about two-thirds of
manufacturing uses agricultural
products as inputs. Jenkins (1999) uses agricultural output as a
proxy for quarterly real GPD
while Nyawata (2001) uses manufacturing output.
- 7 -
The period-average official exchange rate against the U.S. dollar
is used as a proxy for the
expected returns on foreign currency, in the absence of a
continuous time series for the
parallel market rate. This variable was also adopted by Jenkins
(1999), who notes that
“illegal transactions in the foreign currency markets by wealthier
Zimbabweans have tended
to occur at the official exchange rate through the current account
rather than at the parallel
market rate (see page 406 of Jenkins, 1999).” All time series have
been seasonally adjusted
except interest and exchange rates, which do not exhibit seasonal
patterns. Summary
statistics are provided in Table 2.
9
III. I
NFORMATION
CONTENT OF FINANCIAL VARIABLES
We begin by examining the significance of each financial variable
for determining the price
level using bi- and multivariate Granger causality tests. The
approach adopted here follows
Bernanke and Blinder (1990). The marginal significance levels of
bivariate causality tests
for the full sample and for two subsamples are reported in Table
4. The results suggest that
currency in circulation is a significant predictor of the price
level whereas other financial
variables are generally not. Real GDP Granger-causes changes in
the price level in the full
sample, pointing to the importance of possible supply-side
explanations for price level
movements. During the period 1996:1–2001:12, the causality of
output reverses itself,
suggesting that high inflation has adversely affected output
growth. Reserve money Granger
causes price level movements in the period 1980:1–1995:12.
Bivariate causality from the price level to financial variables
and interest rates is also shown
in the data, and is quite significant. This is counterintuitive,
as one would expect changes in
financial variables to lead changes in the price level. The lack
of a statistically significant
causal relationship between the exchange rate and price level is
worth emphasizing, in light
of the relatively close movements of these two variables during
the sample period (Table 1).
The importance of the exchange rate variable is also supported by
Odedokun (1997).
For the purpose of examining the causality between financial
variables and the price level
and, in particular, to shed further light in the relationship
between the official exchange rate
and the price level, we use multivariate Granger causality tests
for three sample periods
(Tables 5a, b, and c). In the full sample, the official exchange
rate Granger causes
movements in the price level when accompanied by other financial
variables. One way to
explain this is to argue that exchange rate movements impact the
price level more through
changes in other variables. For example, depreciation might be
accommodated by a
loosening of monetary policy, which then causes inflation to rise.
The causal relation is
statistically insignificant in the subsamples. Other results are
broadly similar to the results
9
Stationarity of
economic time series is tested using the augmented Dickey-Fuller
(ADF)
and Phillips-Perron (PP) tests. Table 3 reports the test
statistics with and without a trend.
Based on the results, all variables exhibit stationarity in
first-difference form and are
integrated of order one (i.e., I(1)). Critical values are based on
MacKinnon (1991).
- 8 -
from bivariate analysis. However, narrow money significantly
Granger-causes movements in
the price level for the sample period up to end-1995. The causal
correlations seem to break
down during the estimation period starting in 1996:1. We return to
this issue in Section IV.
To analyze the monetary transmission mechanism in Zimbabwe
further, we estimate a vector
autoregressive model comprising the price level, real GDP, and all
financial variables used in
the Granger causality tests to conduct variance decomposition
analysis. This type of analysis
can be useful in clarifying what percentage of the variance of the
forecasted variable (price
level) can be attributed to its own variance and that of other
variables (Table 6). The results
are consistent with the above results from Granger causality tests
and indicate that currency
in circulation plays a key role in determining the price level in
the full sample.
The analysis for the full sample indicates that a lag, ranging
from 6 to 12 months, exists for
the impact from an initial shock to currency in circulation to the
price level.
10 Furthermore,
the official exchange rate is significant in the vector
autoregression, although its impact on
the price level is small. The result also suggests that the
pass-through effect from the
exchange rate to the price level reaches its peak at 18 months
after the initial shock in the
full sample, at which point the exchange rate explains about 20
percent of the price level
variance. This indicates partial exchange rate pass-through to
domestic prices in Zimbabwe.
11
During 1980:1 – 1995:12, the variance of reserve money becomes a
significant determinant
of price level variance, suggesting a possible role for it as a
nominal anchor. Own variance is
more persistent, which may be in part due to the relatively lower
variance of inflation in this
period (Table 1). During the high inflation period
(1996:1–2001:12), own variance seems to
dominate other sources of variance, except for the variance of
deposit interest rate, which is
relatively large. The reason for the dominance of own variance in
this period could be due to
high “noise” in price data (i.e., large standard error). Another
possibility is that non-market
mechanisms that were introduced by the authorities in recent
years, such as widespread use
of price controls and non-market clearing interest and exchange
rates, and the rapid growth
of informal activities, have weakened the relevance of official
statistics to measure economic
activity.
These results, in particular the apparent failure to obtain a
significant monetary impact on the
price level other than for currency in circulation, except for the
earlier subperiod, are worth
pointing out, given that other studies find a strong relationship
between broad money and the
price level. This could be due to the liberalization of Zimbabwe’s
financial markets in the
10
The results are
robust for alternative ordering of the variables. The roots of the
polynomial
are within the unit circle and hence the system is considered
stable.
11
Choudhri and
Hakura (2001) report a greater long-term pass-through effect for
Zimbabwe,
about 35 percent, based on single-equation difference equation
specification, which is close
to the average for medium-inflation countries.
- 9 -
early 1990s, which could have caused instability in monetary
aggregates, similar to the
experience of other developing countries (see Cottarelli and
Giannini, 1997). As a result,
money demand relations could have changed, eroding the usefulness
of historical relations
for monetary policy implementation.
While financial markets in Zimbabwe are somewhat developed and
some financial deepening
has taken place in the country, these developments are relatively
recent (Gelbard and Leite,
1999).
12 However, the demand for cash may be less affected by
financial liberalization than
the demand for other monetary aggregates since the demand for
currency is associated with
transaction demand, which is relatively stable relative to GDP.
Changes in monetary policy,
including in reserve requirement ratios, are also likely to have
an impact on money demand.
13
Furthermore, the volatility of broader monetary aggregates
reflects measurement problems,
for example arising from changes in the definition of the
aggregates and changes in
Zimbabwe’s exchange controls (in particular, foreign currency
deposits, which are part of
broad money, have been subject to exchange control changes).
Finally, interest rates have
been negative in real terms, particularly before their
liberalization in the early 1990s, thus
making them less important for portfolio decisions.
Because of the lags involved in implementing monetary policy, an
important consideration
in choosing an operating target is the extent to which this target
behaves as a leading
indicator of inflation, which is the ultimate objective of
monetary policy. We have provided
evidence to suggest that currency in circulation is a more
consistent predictor of future price
movements than any other financial variable. However, the rapid
acceleration of inflation in
recent years has weakened this relationship. To examine further
the role of monetary
variables in determining the price level, we analyze whether a
well-defined money demand
function exists that can provide a basis for monetary policy to
influence the price level.
IV. A Q
UEST FOR A
NOMINAL ANCHOR
Is there a monetary variable that could serve as a nominal anchor,
or can the exchange rate
play that role? For this to be the case, two elements are needed.
First, there needs to exist a
well-defined long-term relationship between the price level and an
anchor variable. Second,
monetary policy needs to be credible and supported by other
policies (fiscal, in particular).
This paper focuses on the first issue.
12
Jenkins (1999)
notes that financial repression was probably important for suppressing
the
demand for money and facilitating arbitrage, at least prior to
financial market liberalization.
13
Since 2001 the
Reserve Bank of Zimbabwe has allowed banks to onlend a portion of
their
statutory reserve balances, thereby lowering the effective reserve
requirements.
- 10 -
Zimbabwe has experimented with exchange rate and monetary anchors
in the past, but as we
discussed earlier, these policies failed to provide guidance for
price expectations. This is for
the most part because these policies have lacked credibility and
were not supported by other
macroeconomic policies, in particular fiscal policy.
Studies by Jenkins (1999) and Nyawata (2001) report a
well-identified relationship between
monetary variables and the price level. However, empirical
evidence to support an exchange
rate anchor is more elusive. We will identify a money demand
relationship using the
Johansen and Juselius cointegration technique (Johansen and
Juselius, 1990). This has the
advantage that it is not necessary to specify the causal relations
between variables ex ante; an
indication of weak exogeneity can be inferred from the results
(Wald tests).
Empirical models typically specify money demand in terms of real
balances, implying price
homogeneity, that is, unitary elasticity between the price level
and monetary aggregate. This
is because of the econometric problems associated with the use of
nominal rather than real
variables as the dependent variable. Furthermore, empirical
research suggests that the
demand is for real balances rather than for nominal balances. A
generic form of money
demand equation can be written as follows:
M/P
= f(y, R), (1)
where the demand for real money balances,
M/P, is a function
of the chosen scale variable, y
(in this study, we use real GDP), and a vector
R of other variables
thought to be relevant for
explaining the demand for money (e.g., the rate of return on other
assets relative to money),
were
M is the money aggregate and P is the price
level.14 The “own” interest rate influences
money demand positively because a higher return on money increases
incentives to hold this
asset; interest rates on other assets affect money demand
negatively through the substitution
channel. Currency depreciation, by increasing the cost of holding
local currency, will have a
negative impact on money demand.
High inflation affects money demand adversely because it erodes
the real value of money
balances, particularly non-interest bearing. In money demand
studies, inflation is often used
as a proxy for the return to real assets. Sriram (2001) stresses
that it is important to select the
opportunity cost variables properly, as omitting any variables
tends to bias income elasticity
estimates. Jenkins (1999) also includes rationing variables for
foreign exchange and credits,
in order to help identify a stable money demand relation for
Zimbabwe.
14
Sriram (2001)
provides a good survey of recent empirical money demand studies and
how
to interpret variables included in the money demand function.
- 11 -
A. Full-Sample Estimates
The cointegration results for currency in circulation are reported
in Tables 7 and 8. Year-onyear
changes in the price level and exchange rate performed better than
monthly changes of
these variables and are therefore used here. This may be because
year-on-year inflation is
less volatile and more likely to be used as a basis for inflation
expectations by the public.
15
Table 7 presents the relevant Johansen statistics, while the
cointegrating vector for currency
demand can be written as follows (including constant
term):
16
RCUR
= 5.533 +
0.9608*RGDP + 0.9373*TDRATE
– 1.2477*INFLATION
(0.2114) (0.3058) (0.2949)
– 0.6586*
DEPRECIATION
– 0.0706*FININNOV (2)
(0.1154) (0.0130)
The estimated long-run elasticity vis-à-vis real GDP is 0.96 and
broadly in line with Sriram
(2001) and Jenkins (1999), but higher that Nyawata (2001). The
estimated income elasticity
is statistically not different from unity and consistent with the
transaction motive for holding
money. The parameter estimate for the three-month deposit interest
rate, which is statistically
significant, is positive but contrary to expectations. Interest
rates, for the most part, have not
played an important role in allocating financial assets in
Zimbabwe, as nominal interest
rates remained virtually unchanged until their liberalization in
the beginning of the 1990s
(Figure 4).
17, 18
Interest rates adjusted for inflation have
frequently been negative. Furthermore,
real currency holdings of the public generally rose after the end
to the financial
repression, which coincided with the rise in nominal interest
rates.
Inflation has had a significant direct impact on currency demand.
The parameter estimate for
inflation has the expected negative sign, which suggests that the
willingness to hold cash
balances is negatively influenced by inflation. It is also evident
in the negative parameter
estimate for depreciation that currency substitution has a role to
play in money demand.
15
Jenkins (1999)
uses the year-on-year rate of currency depreciation as a measure of
the
expected return on foreign currency holdings.
16
Estimated standard
errors are reported in brackets.
17
See also Jenkins
(1999) for a discussion on nominal and real interest
rates.
18
Interest rates in
Zimbabwe were liberalized only in the early 1990s and formal capital
controls remain in place. However, exchange rate depreciation
provides an incentive for
capital flight. As shown below, the interest rate variable is not
significant for the sample
ending at end-1995.
- 12 -
Financial innovation is associated with lower demand for currency,
as would be expected,
given that it is measured as the ratio of broad money to currency
in circulation.
Table 8a rejects the joint-test for normality of the estimated
residuals, although skewness is
not a major problem except for
FININNOV (Figure
6).19 Non-normality leads to inefficient
but unbiased and consistent estimators.
20 The residual
correlation matrix shows that all offdiagonal
elements are close to zero (Table 8b).
Pairwise Granger-causality was examined using Wald tests (Table
9).
21 The
results suggest
that currency demand can be treated as weakly exogenous vis-à-vis
inflation. Inflation cannot
be treated as weakly exogenous.
22 Wald tests clarify the channels
through which exchange
rate changes could impact the domestic economy. This “chain of
events” implies that
currency depreciation influences inflation through the interest
rate channel, which then
affects the demand for currency. Changes in currency holdings
impact inflation through the
demand effect. It therefore offers evidence for the effectiveness
of monetary policy to
counter the inflationary effects of depreciation.
Figure 7 illustrates how shocks to currency demand, output, the
interest rate, inflation, the
exchange rate, and financial innovation affect inflation (measured
by one standard deviation
change in each variable). The results are consistent with the
earlier discussion on factors that
contribute to price level movements (Section III). Shocks to
interest and exchange rates
impact inflation with a lag, from 6 to 10 months (shorter for the
exchange rate variable), and
these effects are statistically significant. Both effects become
weaker after about 12 to 14
months. A shock to currency demand, on the other hand, influences
inflation with a lag of
about 7 months, and remains significant for the entire sample
period. This suggests that
monetary policy aimed at currency demand can be effective in
containing inflation. The
“own price” effect is highly significant and persistent. Other
variables do not exert significant
influences on inflation.
We do not find well-identified demand functions for reserve,
narrow and broad moneys. In
this respect, our results are somewhat different from those of
Jenkins (1999) and Nyawata
(2001), which may be due to the use of higher-frequency data in
this study and differences in
the specification of variables. Regarding the latter, the variable
used to measure the demand
19
All unit roots of
the VAR are within the unit circle. Joint test for heteroscedasticity of
the
estimated residuals is significant at the 1 percent marginal
significance level. However, there
is no significant autocorrelation in the estimated
residuals.
20
Kmenta
(1986).
21
These tests can be
used for inference on weak exogeneity.
22
This should be
expected in an economy where the exchange rate is flexible.
- 13 -
for currency in our study is currency in circulation, which
comprises currency outside banks,
a concept used by Jenkins, and bank holdings of cash in vault.
Currency in circulation is
readily available in the Reserve Bank of Zimbabwe’s balance sheet
and, hence, provides a
basis for policy decisions; cash in vault, however, is reported
less frequently and is typically
estimated. Other variables in Jenkins’ study, such as proxies for
credit and foreign currency
rationing, were unavailable to us.
23 Furthermore, the sample period used in
this study
includes the recent acceleration in inflation, which is likely to
have distorted the structural
relations.
Regarding specific results, Jenkins fails to establish a long-run
relationship between demand
for currency and inflation (page 406 of Jenkins (1999)). Currency
substitution, however, is
significant in both Jenkins’ and Nyawata’s studies. Jenkins fails
to identify a cointegrating
relation for bank deposits, citing changes in the classification
of bank deposits.
B. Estimates for the Subperiod 1980:1–1995:12
In light of our earlier discussion, there seems to be a strong
case to suggest that parameter
estimates may not be constant in time. To account for this
possibility, we estimate equation
(1) for currency in circulation covering two separate sample
periods. The results for the
period 1980:1 – 1995:12 are reported below, which indicate that
the demand for currency
reverts to a standard demand function (Table
10):
RCUR
= 5.6952 +
0.9808*RGDP – 0.8328*DEPRECIATION –
0.0912*FININNOV (3)
(0.1642) (0.1534) (0.0135)
where
TDRATE
and INFLATION drop out
since their estimates are not statistically different
from zero. The nonsignificant parameter estimate for the deposit
interest rate reenforces the
view that interest rates were not an important factor in the
allocation of financial assets prior
to the liberalization of bank interest rates.
The parameter estimates for
RGDP,
DEPRECIATION, and FININNOV
remain more or less
unchanged and highly significant. One possible explanation for the
insignificance of the
parameter estimate for
INFLATION in this
sample is that this variable captures the increase
in inflation volatility over the past few years, which is not a
factor in the current estimation.
Tables 11a and b report residual diagnostics tests for VAR. Wald
test statistics are provided
in Table 12. Break-point F-tests, based on recursive estimation of
the VAR for the period
1996:1-2001:12, indicate that the estimated parameters have not
remained constant.
24
23
Jenkins uses
proxies for foreign currency availability and government domestic
borrowing.
24
These tests are
performed under the null hypothesis of constant parameter. The test
statistic
has an F-distribution, and is highly significant (it is related to
the CUSUMSQ statistic).
- 14 -
Regarding period 1996:1–2001:12, we are unable to establish a
money demand relation for
any monetary variable. Indeed, the statistical relations break
down, which reflects the rapid
rise in inflation and the accompanied distortions in the
economy.
V. C
ONCLUSIONS
This study has analyzed the underlying determinants of prices in
Zimbabwe using a wide
range of statistical techniques. The results are robust to
alternative specifications. The key
results for the full sample are as follows. First, there is a
strong linkage between currency in
circulation and the price level. This suggests that currency in
circulation would provide a
good leading indicator of future price movements. Second,
cointegration analysis establishes
a well-identified long-run money-demand relation for currency in
circulation, suggesting
that this monetary aggregate could be helpful to the Reserve Bank
of Zimbabwe as an
intermediate monetary operating target. Third, reserve money,
which the Reserve Bank
of Zimbabwe has used as an intermediate policy target, is
ineffective in the current highinflation
environment, because the demand for reserve money is not
welldefined, while its
information content for predicting future price movements is weak.
Fourth, well-defined
money-demand functions for narrow and broad money cannot be
establised in the full
sample.
25 Sixth, statistical relations seem to break down during the
high-inflation period
of the past few years. This raises serious challenges for monetary
policy implementation,
particularly regarding the appropriate anchor to facilitate
disinflation in the Zimbabwean
economy.
26
It has been argued that the exchange rate could serve as a nominal
anchor in Zimbabwe. As
experience has shown, however, pegging the exchange rate has not
succeeded in constraining
other—namely, monetary and fiscal policies—I therefore believe it
has not been a credible
policy anchor. This may in part explain its low information
content for predicting future price
movements. This study’s analysis suggests that exchange rate
changes have an impact on
domestic prices through the currency-substitution channel and
influence the demand for
currency indirectly through the interest rate channel. The
pass-through effect to domestic
prices is only partial, which does not mean that exchange rate
changes are insignificant. The
Reserve Bank of Zimbabwe would be well advised, therefore, to
counter inflationary effects
arising from exchange rate changes with an appropriately tight
monetary policy.
These results need to be interpreted with caution. Although the
results appear to be robust for
alternative model specifications and are consistent with other
studies in this topic area, the
estimated parameters are shown to be unstable owing to the rapid
rise in inflation since the
25
Kochhar (1996)
provides an analysis for using alternative definitions of reserve money
in
the context of IMF-supported programs.
26
See, for example,
Eichengreen and others (1999) for a comprehensive discussion of the
use
of various nominal anchors and strategies during disinflation.
- 15 -
late 1990s. It is possible, therefore, that once inflation has
been brought down to a relatively
low level, another monetary aggregate, such as reserve money,
could become useful for the
conduct of monetary policy. Nontheless, high inflation and the
accompanying policies have
undermined the stability of structural relations, for the reasons
discussed earlier, and this is
likely to complicate macroeconomic management in the future.
Finally, I wish to emphasize that economic policies are only
effective if accompanied by
credible and genuine commitment of the authorities. In the past,
the credibility of monetary
policy has been undermined by the lack of support from fiscal
policy, as well as the lack of
consistency in policy implementation. Strengthening the Reserve
Bank of Zimbabwe’s
independence and clarifying its policy objectives should assist in
enhancing its credibility.
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