Zimbabwe: how to beat hyperinflation

Zimbabwe is in a truly horrible situation, including crippling hyperinflation. I am not quoting any numbers here, they would be obsolete to quickly... Mugabe has royally mismanaged his country, but he is not eternal. So, once the economy is half-way decently managed, how could one get out of hyperinflation?

The obvious answer is of course: stop printing money. But this is not that easy. Without confidence in the currency, prices will continue to rise, at least for a while. Government expenses still need to be met in the meanwhile, in particular civil servants, and there is no meaningful way to raise taxes. But even with a sound fiscal policy, there is no guarantee that hyperinflation can be beaten. For example, Beatrix Paal shows that a policy of stabilizing inflation though the management of public debt is essentially indeterminate and can lead to hyper-inflation, thus being ineffective. Thus, the critical point is to restore confidence in monetary policy while continuing to pay for government services.

Makinen and Woodward show that Taiwan managed to beat hyperinflation by guaranteeing high real interest rates on bank accounts. This seems like classic anti-inflationary monetary policy to the extreme.

I think the best solution is to delegate monetary policy to an entity outside of the country. This is what Cooper and Kempf advocate: dollarization or a currency board. Dollarization means abandoning local currency in favor of another one. But if one ultimately wants some control over monetary policy, this does not sound like a good policy.

In a currency board, the exchange rate with a base currency is set by law, thus difficult to change unlike a fixed exchange rate regime. In addition, every bit of currency in circulation is backed by the base currency (or titles in said currency): anybody can exchange at the predetermined rate at the central bank. Such currency boards have been very successful in creating confidence in the local currency in various countries from the former Eastern European Block, where the IMF helped building up the necessary foreign reserves. So far, the only currency board that failed was the Argentinean one, due to unsustainable local fiscal policy.

A currency board has worked superbly to end hyperinflation in Bulgaria, as shown by Stefka Slavova. But as the Argentinian example shows, and as Thomas Sargent argues in a celebrated book, sound fiscal policy is still needed from the start, but it is not sufficient, as also Gustavo Franco showed.