Inflation has been raging wildly in Iran for decades, such that the taming of this monster has become an unfulfilled public wish.
Occasionally, it calms down a little and provides respite to people, only to soon ride another wave of price increases that inundate families and their livelihoods.
Why is inflation so relentless in Iran? How come inflation is rarely an issue in many other countries? What policies are needed to curb inflation? Why do Iranian politicians fail to take such policies? These gnawing thoughts and nettlesome questions have long been on the minds of the public; many economists have given answers to them. But the problem remains unsolved. Why?
Hadi Salehi Esfahani, an academic with Illinois University at Urbana-Champaign, sought to answer these questions in an article for the Persian economic daily Donya-e-Eqtesad. A translation of the text follows:
Common solutions to curb inflation, those which underline the necessity of reducing money supply and budget deficits, rarely take into account the complexities of achieving economic stability and growth. They don’t consider the social and political conditions of the time while for the reasons that will be mentioned below, the state of the society and the abilities of the policymakers are much more important than the amount of the budget deficit and the growth of money supply.
Common Theories
First, let’s review common theories regarding the causes of inflation. The excessive creation of money in the economy is believed to be the main root of inflation. Other major theories also blame the role of budget deficit, expected inflation and supply changes along money growth. According to these views, inflation is the outcome of the excess of total demand over total supply. This excess may come from a decrease in total supply (such as when the production capacity decreases following natural disasters or lack of investment or infrastructure), or as a result of increases in demand components (for example, the increase in budget deficit, or the creation of liquidity in the banking system).
The rise in expected inflation can also lead to excess demand; people will try to buy more goods when they feel that prices are going up. At the same time, the expectation of higher inflation creates an opportunity for sellers to raise their prices sooner, buyers accept these price increases more easily, and consequently, current inflation rises along with expected inflation.
Given this, it seems that the fastest way to contain inflation is by reducing the growth of money supply and budget deficit. The argument is that supply shocks are generally beyond policymakers’ control and they can’t do much about these shocks. Expected inflation, when the necessary restrictions are placed to control the growth of money supply and budget deficit, should not increase; it may even decrease. Therefore, achieving economic stability should not be a problem if the money supply and the budget are handled correctly. But the reality is that, depending on the circumstances, controlling the growth of money supply and budget deficit may be complicated and difficult.
Alternative Factors
The most important aspect of this complexity is the presence of numerous and sometimes unpredictable factors that should be dealt with in the process of achieving stabilization. As a result, although the general approach is relatively clear, the details of the work and the issues that emerge during the process are unclear; there is no simple predetermined instruction to guide officials step by step. Therefore, the motivations and abilities of policymakers are elemental.
To make things clear, think of a relatively obvious issue. Reducing the budget deficit through raising taxes or cutting government expenditures, each will be to the disadvantage of one or more groups of the society and fuel social and political tensions. For example, limiting the subsidies of essential goods and energy, or keeping the salaries of government employees low will lead to the dissatisfaction of a large number of people.
Likewise, cutting the rent of influential groups puts pressure on policymakers. Therefore, it is important to decide which government expenditures should decrease and which revenues should increase in order to reduce the inflation rate to an acceptable level without affecting the economy and creating social and political instability.
One complication is that the government has to convince many groups to pay costs in the short- or medium-term and then benefit for the long-term; there should be a minimum of fairness and justice among social groups when it comes to the redistribution of income from the implementation of this policy.
In addition, the public must believe that the adopted policy will be followed in the future so that inflation will eventually subside and other promises will be delivered; otherwise, people will not accept the government’s policy, which not only makes it difficult to start the work, but also weakens the motivation to continue stabilization process. Basically, when inflation reaches high levels, doubts about the capabilities of the government and the central bank become stronger; it gets harder to gain people’s trust and this, in turn, may dampen the motivation of policymakers. The more pluralistic, the more corrupt and the less transparent the society, the more difficult it will be to find and implement necessary policies for stabilization.
You need policymakers who have both the right motivations to curb inflation and help the growth of the entire economy and also intelligently anticipate the upcoming issues as soon as possible to overcome all these problems in a changing and uncertain environment.
In such a situation, prefabricated instructions are usually of little use unless they are adapted to the specific circumstances at hand; that will only work for a short time.
Even when the government starts with the right action, the change in the situation will soon lead to incompatibility of existing conditions, which will necessitate the revision of policies.
How to Get Prudent, Motivated Policymakers?
The political elites of the country usually appoint policymakers. However, this process is usually carried out in the context of social and political structures that play a major role in the formation of the characteristics of the policymaking team.
A key aspect of this role is how the elites deal with the dilemma of choosing between their acquaintances and non-affiliated experts. Naturally, the elites prefer to choose policymakers from their trusted relatives and associates but this limits the possibility of employing prudent policymakers.
In some societies, the circle of trustworthy associates is relatively big and the elites do not have a very big problem when it comes to finding a strong team. In some other societies, this circle is small and the formation of a strong team is less probable. Such societies are almost chronically affected by instability and poor economic performance.
In the short-term and under favorable conditions, the shortcomings of an ordinary policymaking team may not be that significant, but the world is always changing and sooner or later the economy will face shocks that, in the absence of a strong management, will lead to instability and crisis. When the elites find their circle of trustworthy associates is small, it won’t be an easy task to escape this fate because economic instability fans the flames of mistrust and creates a vicious circle that give rise to a crisis in society. Of course, this does not mean that one cannot escape from the vicious circle of bad conditions and instability.
In some countries, the elites have managed to find a mechanism to find, train and attract specialists, but this is a long-term solution that is not always possible to achieve.
To end this cycle of vice in the short- and medium-term, the elites must come to the conclusion that the emergence of a crisis poses risks for themselves and the whole society, which are no less than those of employing outsiders as policymakers.
We need to accept that when the conditions are not good, it is difficult to face the challenge of economic stabilization; it requires intelligent experts and sufficient motivation to save the economy. We must find ways to find and attract such people.
