With apposite monetary policy instruments at its disposal, the Central Bank of Iran is ready to implement “inflation targeting” measures, the CBI governor said.
“Within this policy, the ‘target inflation’ approach will act as the compass guiding the CBI’s monetary and currency policies,” Abdolnasser Hemmati wrote in a note in his social media account late on Friday.
Inflation targeting is a central bank strategy that specifies an inflation rate as a goal and adjusts monetary policy to achieve that rate. Inflation targeting primarily focuses on maintaining price stability, but is also believed by its proponents to support economic growth and stability.
The assumption is that the best a monetary policy can do to support long-term growth is to maintain price stability, and price stability is achieved by controlling inflation.
Hemmati pointed to the galloping high inflation as the bane of Iran’s economy in the past decades, adding that the new policy will be implemented in tandem with other monetary and currency measures to stabilize macrocosmic indicators.
To realize the inflation target, the senior banker added, the CBI intends to manage interest rates through open market operation. “The short term interest rate set in the interest rate corridor would be a mid-term inflation target,” he wrote.
The OMO and creating an interest rate corridor (IRC) are the main components of the central bank’s new monetary policy that started operation in January.
Floor and Ceiling
Under the IRC framework, the CBI sets the floor and ceiling of policy rates and lets other money market rates, such as interbank rate, move within this setup.
OMO is a financial instrument through which central banks buy and sell securities in the open market to expand or reduce money supply.
Within this framework, central banks can buy government bonds to increase the money base (cash reserves) and by extension curb inter-banking lending rates. By the same token, selling government bonds reduces the base money and raises interbank rates.
It constitutes a key instrument of monetary policy under the market based system of monetary management. Essentially, it is used by monetary authorities to regulate the cost and availability of credit in the banking system and influence the level of money supply.
In addition, within the framework, banks can hold bonds as collateral to borrow from the CBI.
Hemmati said the success of an inflation targeting policy is contingent on adequate volume of bonds issued by the government.
