19226
Build Credibility
Economy, Business And Markets

Build Credibility

A central bank's mandate is to control inflation and maintain the value of a country's currency. For the Central Bank of Iran, those mandates have become mired with the government's policies and political influence. To reverse the situation, the bank should strive to gain credibility in the markets, pursue inflation management and set monetary policy, accordingly. But the government also has a part to play. It should give the central bank its independence and have more fiscal discipline. With all this, the central bank "can achieve anything."
In an exclusive interview with Financial Tribune, Gianluca Benigno, a professor at the London School of Economics, and Pierpaolo Benigno, a professor at LUISS Guido Carli and EIEF, outlined the role of CBI and government in controlling inflation and managing exchange rates. Excerpts follow:

Q What should the CBI priority be: curbing inflation or managing forex rates?
Pierpaolo: In the past, the conventional view by the IMF was that exchange rates needed to be managed in order to control inflation. Now that view has changed. The new view is that it's better to have a stable control over domestic prices. That gives you control of the value of your currency with respect to other currencies.

Q How can the regulator manage to do this?
Pierpaolo: It is a matter of credibility. If you are not credible, if the institutional setting for having inflation target is not sufficient, as is in Iran, where there is fiscal dominance—meaning the treasury is not very disciplined—it will affect inflation and lead to the depreciation of the rial. To move to an inflation targeting regime, you need to have an institutional setting in which the treasury starts to make surpluses.
Gianluca: I agree on the importance of inflation targeting and its credibility. But also it is important for a developing economy to manage foreign exchange rates. This is because in a stable environment with a lot of capital inflows, there is the risk of appreciation of exchange rates. That may adversely affect the exporting sector and economic growth. So, it is important to put control over the capital account and capital inflows, which is what some of these developing economies have done.

Q Can Iran have a 4% inflation? What needs to be done?
Gianluca: I think in general, for an economy that is open and developing, it's not that easy to have a stable 4% inflation, as exchange rate fluctuations and imports and exports have significant effects.
For Iran, the issues that must be addressed to manage inflation are creating the institutional framework, in terms of central bank independence, having a credible fiscal side that does not behave in a deficit prone way, which helps in stabilizing inflation expectations and unifying the foreign exchange rate regime.

Q How can the government help?
Pierpaolo: For Iran, the first step is to have a treasury that is not always in deficit; if it happens to be, it can manage it well. A responsible and solvent treasury is the first prerequisite to having a stable value of money. When you have a government with an ongoing deficit, you usually end up with inflation.

Q What is your take on the CBI's actions? Why are they lowering interest rates?
Pierpaolo: It seems to me that the drop in inflation that Iran has experienced is not much because the central bank has been able to lower inflation. But because the conditions are not good, the economy is not doing well, a sort of recession is going on, and furthermore sanctions have been partially eased. Low growth is obviously putting downward pressure on prices, independent of what the central bank does. Iran has low inflation with respect to what should be its potential inflation. So, instead of having 25% inflation you have 15%. That’s not the success of the central bank; it is the fact that the economy is going bad.
When you want to control inflation, the direction you want to give to interest rates depends on pressure of prices. When you see downward pressure on prices, then you lower interest rates. Currently the CBI is under its announced inflation target, and their target is 20%. So, they are lowering interest rates because economic output is below potential. This would put inflation at 20%.

Should the central bank raise rates and curb inflation, or should it opt for a more gradual approach?
Gianluca: Iran should adopt a gradual approach towards single-digit inflation. Don’t be too ambitious, saying we're going to target inflation at 5% in two years time. Start from a 15% inflation target and then lower your target to 12%.  A less ambitious target … it's easier to attain. Once you achieve 12% inflation, then economic agents will believe that you would be successful in achieving lower inflation levels. This way you gain credibility and that facilitates the process.
Pierpaolo: The issue is how you want to lower inflation from what it is now. If the central bank is not credible, then lowering inflation will cost a lot, in terms of recession. Because you have to increase interest rates a lot to do so. That's because inflation expectation has not been lowering down, as no one believes that you are going to achieve your target.
Instead, if you start one now, and say you're going to achieve 8% target inflation, give a sort of schedule of how you want to achieve a low inflation in the future independent of the conditions that you are going to face, then you know agents are going to, if this is credible, and the credibility comes from the fact that fiscal policy is disciplined; then if it is credible you achieve it at lower cost

Q What about growth hawks who are pushing the bank to cut rates to boost the manufacturing sector?
Pierpaolo: So, the central bank lowers interest rates and it boosts manufacturing, but then it is going to increase prices, and you have the central bank that acts as a subsidiary of the government and does what the government says. And so you will never achieve credible single digit inflation. No one is going to believe you can get there, because you are giving liquidity everywhere.

Q Any final notes?
Gianluca: At the end, inflation is a monetary phenomenon, so it’s the business of the central bank. The central bank controls the value of money. Obviously there are a lot of interactions with the treasury and that’s why you need to keep the treasury disciplined and the central bank independent.
Pierpaolo: At the end of the day, if you are able to be credible as a central bank, you can achieve everything. You can have a central bank that reacts to economic condition and says the sectors are not doing well and lowers the interest rate, but we're still working on 4% inflation.

 

Short URL : http://goo.gl/407vNr

You can also read ...

Westminster Group Hopeful Over Iran Airport Security Deal
UK-based company Westminster Group PLC is still hopeful it can...
Turkey Determined to Protect Companies From US Sanctions
Turkey will take every initiative to protect its companies...
Further Hike in Unified USD Rate
The Central Bank of Iran has increased the US dollar's...
Tesla’s Gigafactory in Nevada, the US
Tesla Inc has flown six planes full of robots and equipment...
Head of Sistan-Baluchestan’s Ports and Maritime Organization Behrouz Aghaei (L) shakes hands with Managing Director of Life Trade Promotion Company Mohammad Arazesh after signing the agreement on May 23.
Life Trade Promotion Company signed an agreement with Sistan-...
No Change in Citroen’s Iran Strategy
In the face of Washington’s withdrawal from the historic...
Iran’s 65-and-over population is projected to rise to make up 11% of the total population in 2036-37.
Iran’s population will get increasingly older over the next...
About 60% of the total volume of NPLs in Iran are considered irrecoverable.
Iranian banks and credit institutions held a total of about 1....

Trending

Googleplus