Zimbabwean Consumer Prices Fall on the ZiG.

By Chinedu Okoye 

Summary:

- Zimbabwe's new gold-backed currency, ZiG, has led to a surprise decrease in prices after an initial uptick.

- Inflation rates dropped by 2.5% in May, marking a significant shift from the country's history of hyperinflation.

- The development has important implications for monetary policy, and could allow for monetary easing if prices stay subdued.

- The central bank's model, which pegs the currency to gold, appears to be instilling confidence in the markets.

CPI Declines In May:

Prices fell in Zimbabwe as the ZiG a currency backed but Zimbabwe's gold reserves is rolled out. Initially there was an uptick in prices as viewed as an initial reluctance by businesses already accustomed to the US Dollar. 

In our paper  Can the ZiG Deliver Price stability?", we stated that that, "these higher prices can be seen as a necessary adjustment to achieve price stability and anchor expectations." 

We added that, "contrary to attributing this to the currency switch, we view this adjustment as an initial price level adjustment," that was  "akin to a monetary policy shock, aimed at correcting the distortions created by the previous monetary regime." In other words, we expected prices to stabilize and follow the trajectory of Gold if the Central Bank's Model is able to instill confidence in the markets.

Whether these price levels are temporary or if the deflationary tales are accurate remains to be seen. We compare our expected and actual price trajectory beliw

The Expected Price Trajectory:

Our initial position on  price trajectory was that there could be a  "disparity between the prices of goods/services in ZiG, and prices of said goods in its Gold equivalent (that is the amount of Gold the unit of ZiG represents)." (From our paper "Economic Implications and Monetary Policy Considerations of Zimbabwe's New Gold-Backed Currency ZiG")

So when prices rose in the first few weeks it was expected. Even though Gold's value was rising as well, which would naturally put downward pressure on ZiG prices as the value of the currency is tied to Gold. There was some expectations that should faith in the currency hold, prices should moderate eventually. 

Gold was headed for the $2,400 range at the moment meaning the price increase was due to perception as the increase in the metal's value  should translates to an increase in the value of the currency which are expected to mitigate price increases.

We wrote further that, "By allowing prices to adjust to their equilibrium level, the economy is effectively correcting the misallocations and inefficiencies that had arisen under the previous currency." A clear indication of expectations of price stability. We further argued that "price changes will be monitored and are expected to moderate as the currency maintains its level against the greenback."

The currency did maintain its level against the USD and prices moved in the opposite direction weeks after.

Actual Price trajectory (One month in):

On May 29, a Bloomberg article by Ray Ndlovu, reported that, the country, which has been "synonymous with runaway inflation, is now contending with deflation following the introduction of its new currency." This marks a directional change in the direction of prices since the initial bump by merchants in the first week of the ZiG's introduction.

The ZiG has gained 1.8% against the USD, inflation computed in ZiG fell 2.5% in May 5th from a month earlier, whilst blended inflation fell 0.6%. Blended inflation uses the local currency and the US Dollar to calculate price changes. On both readings of CPI, prices are on the opposite trend they where at inception (headed downwards) giving some credence to the stance that prices would moderate and that the initial price bump was to be shortlived. 

Monetary Policy Implications:

Price Stability would be key to the success of economic reforms, as a continual reduction would allow for monetary policy easing with adverse exchange rate effects insulated by the currency peg to the Value of Gold, and high interest rates. 

The dual CPI computations using ZiG prices and the blended inflation gives indication that the Central Bank might be focusing on both readings for key interest rate policy decisions, but that remains to be seen. Since the blended inflation incorporates the US Dollar, we could see the Apex Bank refer to its as it will be reflective of real prices and detached from changes in the value of Gold. 

The prospects for price stability hinges on Gold's value against the dollar and the country having enough Gold to back its currency. A change in the former would not always result in a proportionate change in prices in the short run, and the long run stability is dependent on a range of factors, but the exchange rate exposure might be appropriately hedged with the gold peg.