In his mid-term budget speech, Zimbabwe’s Finance and Economic Development Minister, Hon. Prof. Mthuli Ncube identified rising inflation and currency depreciation as the major challenges requiring “the support of all stakeholders and citizens”. Zimbabwe is failing to ward off persistent inflation. According to Ncube’s mid-term budget report, headline inflation increased from 60.7% in January to 191.6% in June 2022.
In this post, I will argue that whilst price and the exchange rate have some importance, preoccupation with them can constrain economic development. I start off by giving a brief background of inflation in Zimbabwe as well as inflation targeting policies, before arguing that sheepishly pursuing currency and price stability equates to commodity fetishism. I then look at the real beneficiaries of price and currency stabilisation policies. Finally, I attempt to demystify value and price in Zimbabwe’s context.
In this post we show that an increase in aggregate demand first generates an increase in the use of productive equipment and then an increase in productive capacity. This suggests we do not need to worry about inflation after a fiscal or monetary stimulus to boost aggregate demand, but can rather expect higher investment in the long term along with utilisation returning to its pre-shock levels.
A stylised fact that characterises modern economies is that part of the installed productive capacity is persistently idle. By productive capacity I mean the productive equipment (mostly fixed capital goods) in existence, together with that part of the workforce which is required to operate it. As we can see in Figure 1, in countries as diverse as Belgium, Finland or Lithuania, the effective utilisation of installed capacity often gravitates below 100%, and around 80% on average worldwide.
Figure 1. Installed capacity utilisation by country (1998Q1-2017Q4).
Source: see Appendix I.
The academic consensus is that there are large margins of idle capacity planned by entrepreneurs. The reasons why entrepreneurs plan to operate with idle capacity vary according to the school of thought considered. At the risk of making a drastic simplification, we can say that while some authors think that entrepreneurs do so in order not to lose market share in the face of changes in demand, others tend to think that there is a rate of utilisation of installed capacity that does not accelerate inflation (Non-accelerating inflation rate of capacity utilisation, NAICU).
Simply speaking, development macroeconomics can be summarized as the challenge of improving productivity and production capacity in poor countries. This involves the conditions that need to be fulfilled for a development process to start as well as the policy framework and instruments that support it. Heterodox approaches consider the state’s role in steering productivity growth as essential (Cardim de Carvalho, 1997). Markets may be able to exploit price signals and adjust resource allocation correspondingly. However, they guarantee neither sufficient profitability of key sectors nor the demand for the goods produced. Both the profit rate and effective demand are conditions for investment to take place (Oberholzer, 2020). It is thus up to the government to make public investment in priority sectors and to apply instruments such as taxes and subsidies in ways that simultaneously allow for economies of scale, higher productivity large-scale employment and demand. This is what is generally referred to as industrial policy (see for example Chang, 2006; Oqubay, 2018).
But this is not everything. Policymakers have to pursue such a development strategy in face of an (often permanent) shortage of foreign currency. While domestic currency can be generated via the domestic banking system including public development banks, the availability of foreign currency is limited unless a country is able to increase exports or restrict imports. Since larger export capacity and a higher degree of import substitution are long-term goals, the current account is determined by domestic and foreign economic growth. This insight has come to be known as the balance-of-payments-constrained model or Thirlwall’s law, respectively (Thirlwall, 1979, 2013): it is reasonable to assume that demand for a country’s exports grows in income in the rest of the world while imports increase with domestic economic growth because a part of increasing incomes is reliably spent on imported goods. Therefore, stability in the balance of payments requires that imports do not grow faster than foreign exchange earnings via exports allow. A limit to the growth of imports implies a limit to the country’s economic growth, hence the balance-of-payments-constrained growth rate.
During the last two decades, Modern Monetary Theory (henceforth MMT) has won wide academic recognition and public influence. Its most prominent achievements include shifting the public debate on the conduct of economic policy and reviving interest in the theory of money. The former tends to attract most of the attention of both advocates and critics of MMT, but this is unjustified. MMT policy conclusions result from its underlying understanding of money, as some of the more illuminating MMT thinkers make abundantly clear (Bell, 2001; Tcherneva, 2006; Wray, 2010, 2014). A far richer assessment of MMT economic policy proposals would result by first considering the foundations of its theory of money, that is, neo-Chartalism.
In a recent article, we contrasted MMT with the Marxist theory of money. We showed that there were four important points of disagreement between these two schools of thought, namely on: (i) the ontology of money, (ii) the state and money, (iii) state economic policy, and (iv) world money and monetary sovereignty. We supported our argument with historical examples that we omit here for reasons of space.
With modern money theory (MMT) receiving impressive attention, the implications this theory has for developing countries have also been discussed more intensely. Emphasizing both its strengths and gaps provides a great chance to further develop macroeconomic strategies for poverty reduction and environmental sustainability.
In brief, the theory starts from the statement that money is issued by the government and brought into circulation via its expenditures. The government does not rely on taxes to fund expenditures when it is itself the source of money. Therefore, money can be created upon demand, is not limited, and can be used by the government to finance all expenditures it considers necessary to achieve policy goals such as full employment or a Green New Deal. The reason why agents in the economy accepts this money only consisting of numbers without any intrinsic value is the obligation to pay taxes. Since the state has the power to impose taxes, individuals need to get hold of money as this is the only way to meet their obligations; this is how the currency is accepted as a means of payments. The government thus has the power to run unlimited deficits because the fact that money is needed to pay taxes guarantees its acceptance even if those taxes do not cover expenditures. In fact, the government should run deficits because it creates the demand required for full employment while a balanced budget constrains it. The government cannot go bankrupt because there is no lack of currency it issues itself. The conditions identified by MMT for the system to work are the following: 1) the country must be sovereign of its own currency and 2) inflation needs to be kept under control. Once the latter starts accelerating due to increased nominal demand stemming from government expenditures, taxes can be increased in order to withdraw money from circulation. However, as long as full employment is not achieved, prices are argued to remain stable.
For several decades, countries of the periphery have been deeply in the grip of debt. The Covid-19-induced crisis has severely accelerated indebtedness and thus increased financial vulnerability. Recent policy measures by peripheral governments and central banks have brought momentary relief, but ultimately represent a manifestation of the interests of finance capital to get the most out of peripheral economies as long as it is still possible.
Because of the dependence of their currencies on international capital flows, political autonomy in peripheral economies is extremely limited due to the possible effects of political decisions on the movement of such flows. The enormous power of financial markets over monetary policy in the periphery is again becoming evident during the current crisis. The crisis in the global periphery is generally much more severe than in the central countries, not only because of often inadequate health systems that have been abandoned under three decades of neoliberal policy. As peripheral assets do not serve as a store of value, “investors” withdrew almost 100 billion dollars from “emerging markets” within three months, constituting a historically unprecedented capital flight. Factors such as the deflation of prices of primary resources, the fall in external demand for manufactured products, and the fall in cash flows due to decreasing remittances and tourism mean that financial pressure has increased even more. Consequently, peripheral currencies significantly depreciated with the beginning of the crisis, in some cases by as much as 20-30%, as in the cases of Brazil and Mexico.