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IB Economics IA : Macroeconomics Monetary Policy (Interest Rates)

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  • Course
  • Economics
  • Institution
  • Monash University (MON )
  • Book
  • Economics for the IB Diploma with CD-ROM

This is a Macroeconomics IA based on Monetary policy that received 12/14 from the IB. The IA discusses the analysis and impact of how Zimbabwe’s central bank decided to hike the interest rates to 70% intending to combat sharp collapse in domestic currency, upsurge in inflation, and lighten the im...

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  • March 30, 2021
  • 6
  • 2019/2020
  • Essay
  • Unknown
  • A+

Subjects

  • ib economics
  • ibdp economics
  • economics
  • economics hl
  • ib economics hl
  • economics ia
  • monetary policy
  • macroeconomics

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Macro Economics - Commentary


ARTICLE


Zimbabwe Reserve Bank governor hikes interest rates to 70%


Reserve Bank of Zimbabwe governor John Mangudya has touted introduction of the interbank
foreign currency market as having helped stabilise exchange volatilities.


HARARE – About US$799 million (R11.62billion) has been traded on Zimbabwe’s official
interbank foreign currency market, with the central bank hiking interest rates to 70 percent and
introducing foreign currency savings bonds, the governor of the Reserve Bank of Zimbabwe said
on Friday, highlighting that inflation would be tamed in the medium- to long-term outlook.
Reserve Bank of Zimbabwe governor John Mangudya has touted introduction of the interbank
foreign currency market as having helped stabilize exchange volatilities. Parallel market and
formal market exchange rates have appeared to converge as banks and bureau de changes ramp
up their activities on the foreign currency markets following liberalization of the exchange rate
regime this year.


“The introduction of the interbank foreign currency market was meant to address the foreign
currency grid-lock arising from widening parallel market activities by harnessing foreign
exchange through the formal market,” Mangudya said in the mid-term monetary policy statement
on Friday.


According to central bank data, as much as US$799 million in foreign currency has been traded
on the official interbank market for forex in Zimbabwe. Prior to this, those holding foreign
currency shunned formal channels because of the 1:1 exchange rate for local currency and US
dollars.


Zimbabwe has also moved to introduce US dollar denominated savings bonds to “promote a
savings culture and to provide reasonable return on (foreign currency accounts) deposits” as well
as “US dollar cash balances held by individuals and firms” inside Zimbabwe.

,Macro Economics - Commentary


The new US dollar savings bonds will bear interest of 7.5 percent per year; have a minimum
tenure of one year; will have tax exemption; and assume liquid asset status in addition to
acceptability as collateral for overnight accommodation by the central bank.


This comes as the Reserve Bank of Zimbabwe has noted an increase in the demand for physical
cash, which it describes as worsening, with unending queues at most banks in the country.
Premiums on bond notes have also started to spike.


“Visitors to the country including tourists are failing to access cash for their domestic
transactions, as they are supposed to buy local currency cash from banks or bureaux de change,”
Mangudya explained.


He highlighted that the central bank was now geared to inject additional notes and coins on a
gradual basis to support productivity and lessen the inconvenience caused by physical cash
shortages to the transacting public.


“The cash injections will not result in an increase in money supply as banks will use their
existing RTGS balances to exchange for cash.”


Economists are, however, worried that additional injection of cash into the economy will fuel
price increases through broadening money supply. The central bank has curtailed the usage of
bank balances for informal parallel market foreign currency dealings through hiking the
overnight borrowing rate to 70 percent, which has been viewed by some economists as marking
Zimbabwe’s return to hyper-inflation.

, Macro Economics - Commentary


COMMENTARY


The article describes how Zimbabwe’s central bank decided to hike the interest rates to 70%
intending to combat sharp collapse in domestic currency, upsurge in inflation and lighten impact
on exchange rate. Interest rates are yearly prices paid for loaning or keeping money. There has
been rife speculation that Zimbabwe is returning towards its disastrous 2009 hyperinflation due
to its poor economic reforms ever since.


Inflation can be defined as persistent increase in the price level of an economy over a time
interval and hyperinflation is its more rapid form. Besides interest rates, Zimbabwe has
introduced “US dollar-denominated savings bonds” as a step to relaunch national currency and to
encourage saving and help reduce spending for an effective decrease in aggregate demand and
hence, inflation. Moreover, to reduce difficulty of physical cash shortages, the central bank will
pump notes. However, this won’t increase money supply as banks will “use their existing RTGS
(real time gross settlements) balances” in return for cash.


The implementation of high interest rates is a contractionary monetary policy example that
uses interest rates and money supply as determinants to decrease the consumer spending and
investment components and hence, aggregate demand. It is used to close inflationary gaps,
where there is excess demand
since Real GDP is greater
than Potential GDP (Ye >
Yp).


Determination of Interest
Rate

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