The effect of liquidity growth on inflation usually emerges with a delay, but what accelerates the growth of inflation in the short run is the speed of liquidity circulation and the share of “money” in the composition of liquidity, which is actually a reflection of inflation expectations.
This was stated by Abdolnasser Hemmati, the former head of the Central Bank of Iran, in a write-up for Ecoiran.com. A translation of the text follows:
The latest CBI report shows the higher intensity of the growth of “money” in liquidity vis-à-vis the decline in the growth of another component of liquidity, i.e., “quasi-money”. Although the growth of liquidity has decreased, it was mainly thanks to the decline in the increasing coefficient of liquidity creation, following restrictions on the growth of banks’ balance sheets and the decline in the growth of “quasi-money”.
The increase in the share of “money” in the composition of liquidity is synonymous with overcoming inflationary expectations and high fluidity of liquidity and the higher speed of its transfer, which indicates an increase in demand for assets compared with liquidity, which has inflationary impacts. Money now accounts for 25% of liquidity, suggesting that its share has been on the rise in the past five years.
Inflation control is contingent upon the serious application of contractionary monetary policies that reduce the total demand in the economy
The 40% growth of monetary base during 2022-23 is also very alarming. Direct borrowing from the central bank to finance the government expenditure has been replaced by an indirect method, i.e., borrowing through banks, which along with the debt and collateral facilities of some non-governmental banks, has led to unacceptable withdrawals by banks from the central bank in the form of overdrafts and repo operations. This high growth of the monetary base can not only keep inflationary expectations alive, but also reverse the downtrend in liquidity growth.
Inflation control is contingent upon the serious application of contractionary monetary policies that reduce the total demand in the economy. As long as the government budget deficit prolongs, it will be very difficult to control inflation, and of course, curtail private sector demand.
Contractionary policies employed to contain inflation normally lead to recession and decline in economic growth in the short term. Controlling inflation is a prelude of growth. In fact, by controlling inflation and economic fluctuations, as well as making the economy more predictable, we can pave the way for investment and economic growth in the medium- and long-term.
Overhauling the central bank’s relationship with the government and oil revenues is one of the ways to help the central bank gain independence in terms of monetary policymaking and controlling balance sheet.
Another point is that reducing the dollar exchange rate is a good policy measure, but removing the dollar from business transactions will not stop the depreciation of the local currency.
No matter what currency you use to trade (euro, ruble, yuan or dollar), as long as the rate of “domestic inflation” is much higher than “foreign inflation”, an increase in the exchange rate or a decrease in the value of the national currency compared to all international currencies will be inevitable. Tying the country’s economy to the dollar, along with the continuation of sanctions, is the effect of inflation, not its cause.
