ASSESSING MONEY SUPPLY, EXCHANGE RATE AND INFLATION DYNAMICS IN ZIMBABWE

Abstract

This paper assesses the money supply, exchange rate and inflation dynamics in Zimbabwe using
monthly data from December 2009 to December 2018, a period when the country was dollarised. The paper
first applies a multivariate regression model to check for the significance of the independent variables. The
multivariate regression model established that money supply and the parallel exchange rate premium have
some significant influence on inflation in Zimbabwe. To eliminate the endogeniety problem associated with
the model and also to allow for the feedback mechanism in the model, the paper applies a Vector Error
Correction Model (VECM). The results from the Johansen cointegration tests indicated that the variables were
cointegrated thus making it possible to apply the VECM. The VECM established that there is a long-run
causality running from the money supply, parallel market exchange rate premium, output gap and inflation as
well as short-run causality running from money supply and the parallel exchange rate premium to inflation.
A monetary targeting framework is therefore recommended to attain long-run macroeconomic stability.