eBusiness Weekly
Blessing Nyatanga
In a purely economic sense, inflation refers to a general increase in price levels and this could be caused by a number of factors such an increase in money supply, reduction of income tax, and increased government spending.
The term inflation narrowly refers to a monetary phenomenon in this context. In this article we are going to pre empty the measures the government could implement to curtail prices that are rising unabated in the Zimbabwean context.
The central bank has various tools at its disposal and these entail open market operations, and exchange rate pegging.
Open market operations
The Reserve Bank of Zimbabwe could employ the (OMO) by buying government securities, such as Treasury bonds, and issuing new money.
The central bank can likewise contract the money supply by selling those securities from its balance sheet and removing the money received from circulation. This contraction is an effective method in reducing inflation because it slows down economic activity.
The reserve requirement ratio
The reserve requirement is when the central bank instructs other banks on how much money they must hold on reserve at a given point in time. When a central bank wants to restrict liquidity, it raises the reserve requirement ratio.
That gives banks less money to lend case in point the Zimbabwean situation, it is prudent that The RBZ raises the reserve requirement ratio and contract liquidity.
The discount rate
The discount rate refers to how much the RBZ charges other banks to borrow funds from its discount window. It raises the discount rate to discourage banks from borrowing. That action reduces liquidity and slows the economy.
Fiscal policy
Fiscal policy is how the government decides to tax and spend in response to economic conditions. This is another demand-side policy, similar in effect to monetary policy.
Fiscal policy involves the government changing tax and spending levels in order to influence the level of aggregate demand. To reduce inflationary pressures the government can increase tax and reduce government spending.
This will reduce aggregate demand and ultimately reduce the level of spending in the economy. The government could also raise the income tax rate. This translates to people paying a higher portion of their income in taxes which means they have less income to buy goods and services. The ultimate effect of this tax cut will lead to a reduction in the inflation rate.
Price controls
With inflation, we will see firms trying to increase prices as much as they can to maintain profitability and deal with rising costs.
One way to try to avoid this ‘profit-push’ inflation is to introduce price controls.
This is where the government sets limits on price increases.
Regarding local prices in Zimbabwe, it is evident that some pricing set by shops are ludicrous and have nothing to do with the prevailing rates but pure predatory tendencies by business people. In a scenario where businesses raise prices unabated and without justification, the government should step in and put price caps so as to curb the spiralling inflation.
Exchange rate pegging
One commonly used method to reduce inflation and keep it low for a country is to peg the value of its currency to that of a large, low-inflation country.
In some cases, this strategy involves pegging the exchange rate at a fixed value to that of the other country so that its inflation rate will eventually gravitate to that of the other country, while in other cases it involves a crawling peg or target in which its currency is allowed to depreciate at a steady rate so that its inflation rate can be higher than that of the other country.
A key advantage of an exchange-rate peg is that it provides a nominal anchor which can prevent the time-inconsistency problem.
With a strong commitment, the exchange-rate peg implies an automatic monetary-policy rule that forces a tightening of monetary policy when there is a tendency for the domestic currency to depreciate, or a loosening of policy when there is a tendency for the domestic currency to appreciate.
The central bank no longer has the discretion that can result in the pursuit of expansionary policy to obtain output gains which leads to time inconsistency.
Another important advantage of an exchange-rate peg is its simplicity and clarity, which makes it easily understood by the public.
Blessing Nyatanga holds a Bachelor’s Degree in Banking and Investment Management from NUST.0784909184/[email protected]
