You can’t reject the proposition that price expectations will be subject to change when foreign exchange rates increase. You also cannot deny that when the monetary policymaking framework is weak, the communication policy does not work effectively and the monetary policymaker does not have an effective nominal anchor to control expectations.
The tool of foreign exchange interventions to help stabilize price should be in the policymaker’s toolbox. However, there are some “buts” with a capital B that, if left unheeded, will abort policymaker’s measures to stabilize the economy, Pouya Jabal-Ameli, an economist, prefaced an editorial for the Persian economic daily Donya-e-Eqtesad with this note. A translation of the text follows:
The first “but” to the above proposition is that the main cause of price instability and inflation is money influencing the inflation process; monetary aggregates expand under the policymaker’s watch. Monetary contraction, and not foreign exchange intervention, is the first priority to stabilize the economy. There is no other way.
You cannot pour gasoline (money) on fire (inflation) every day and expect to extinguish the fire with water (foreign exchange reserves) that is not known to be adequate tomorrow and should be consumed to quench the thirst of people. Commonsense says we shouldn’t pour gasoline in the first place.
If monetary aggregates and expectations are controlled and inflation is kept within a reasonable range, a currency shock will be significantly limited. It will no longer act as a supply-side shock and does not require the policymaker’s intervention.
Second, foreign exchange intervention takes place only by selling foreign currencies in the free market; no reference book on currency policymaking recognizes any other type of intervention than this. None of the textbooks have included ways such as self-styled markets, the classification of forex demand into legal and illegal, policing trade and its mix-up with issues such as money laundering and the criminalization of citizens whose only goal is to safeguard the value of their assets and property.
These have been our artificial measures in the past few years because we were unable to make clean forex interventions with our reserves to tackle the demand shock. When we know forex intervention won’t work with auctions, we need to abandon the currency instrument in practice, period. No more meetings, no more innovation and no more inventions will cure the pain. They will only compound market problems, price distortions, business complexity and corruption.
Third, the fact that currency tools should still be considered for price stability in Iran shows the inaction on the part of monetary policymaker in the past decades. The fact that our monetary policymaking framework is not yet stable, active monetary policy has been stifled and the monetary policymaker cannot shape the expectations of economic players are all due to the diversion from a modern monetary policy framework, which is common worldwide.
I am aware of the problems, shocks and exogenous factors that restrict the policymaker’s actions. Despite that, signs of resolving the difference in domestic capacity with that of the world’s central banks in terms of expertise, analysis and modeling, as well as the use of technical assistance from international institutions are weak.
Moreover, efforts to convince officials, parliamentarians and government decision-makers to devise an active monetary policy and increase the policymaker’s credibility among market players, defining a new nominal anchor in a specific timeframe, strengthening communication and regular reporting similar to the central banks of other countries for promoting monetary and financial stability are not strong enough.
Showing that foreign currencies are not the prime cause can make experts hopeful about a positive future for monetary policymaking.
