Public debt and inflation dynamics: Empirical evidence from Zimbabwe

Abstract

The study seeks to empirically test the hypothesis that public debt has a significant influence on inflation in Zimbabwe, covering the period 1980-2020. The study was motivated by recent trends in public debt and domestic inflation in Zimbabwe, and the need to guide debt-inflation related policy. These latest trends have started to ring alarming bells, which raises questions on the effectiveness of fiscal and monetary policies in bringing macroeconomic stability in the country. Applying the Autoregressive Distributed Lag (ARDL) bounds testing procedure to cointegration and an error correction mechanism (ECM), expanded by incorporating structural breaks, the study finds evidence in support of positive and significant impact of public debt on inflation dynamics in Zimbabwe, particularly in the long run. Based on the findings, public debt dynamics matter for inflation process in Zimbabwe. That is, fiscal policy can be considered to be an important determinant of the effectiveness of monetary policy in Zimbabwe. Therefore, the government should be mindful of increases in public debt as this was found to be inflationary.

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“…Previous researchers on Zimbabwean monetary policy have proffered monetary interventions based on specific variables ignoring this interaction. For instance, Saungweme and Odhiambo (2021) found public debt as the most important tool in managing inflation and economic performance in Zimbabwe. They thus argue for the government to focus on public debt in order to control inflation and economic growth without considering the interplay between public debt, resultant interest rates and exchange rates.…”

“…Inflation peaked at 231 million% in the year 2008 (Njokwe, 2016) coinciding with negative GDP growth rates (Masiyandima et al, 2018). Although the country's economy stabilized in 2009 after dollarization, it faced a liquidity crunch (Mugari and Olutola, 2021) and deflation (Saungweme and Odhiambo, 2021) from 2012. After reintroducing a local currency in 2016, inflation soon spiralled as the foreign exchange rate deteriorated since the local currency was rushed before meeting the requisite fundamentals such as sufficient US$ reserves to defend the currency (Makena, 2020;Saungweme and Odhiambo, 2021).…”

“…Although the country's economy stabilized in 2009 after dollarization, it faced a liquidity crunch (Mugari and Olutola, 2021) and deflation (Saungweme and Odhiambo, 2021) from 2012. After reintroducing a local currency in 2016, inflation soon spiralled as the foreign exchange rate deteriorated since the local currency was rushed before meeting the requisite fundamentals such as sufficient US$ reserves to defend the currency (Makena, 2020;Saungweme and Odhiambo, 2021). By mid-2019, inflation had breached triple figures at 230% and the central bank ceased publishing the economic statistic to contain inflationary expectations from economic agents (Maumbe and Chikoko, 2022).…”