Monetary Vs. Fiscal Policies: A Separation

Monetary policy has once again taken center stage. From the controversy engulfing the ultra-low rates championed by the European Central Bank (ECB) to Donald Trump accusing Janet Yellen, the chair of Federal Reserve of being politically biased, central banks have found themselves in the limelight like never before.

Truth be told, since the financial crisis of 2007-08, the Federal Reserve and other major central banks have mostly borne the brunt of the catastrophe and indeed done much to alleviate it. They slashed rates to historic lows and embarked on a massive quantitative easing (QE) to prevent the recession turning into a depression.

Ironically, the issue of central banking has also found its way into the mainstream economic dialogue in Iranian circles. The government has prepared a new central bank bill that will go to parliament soon, to replace a  law half century old.

However, unlike the debate in the advanced economies, which swirls around the fact that central banks have become too powerful and undemocratic, the question here is to grant some much-needed independence to the Central Bank of Iran, which prior to the Rouhani administration could barely claim a voice for itself. In a rare feat, the CBI has asked the public to air its views on  improving the law.  

The bill in question, hailed by the government and the CBI as the solution par excellence for sloppy policymaking of the past, has indeed some very good features. Article 14, for instance, states in no uncertain terms that “providing loans (read aid) to ministries, government institutions and their affiliates or guaranteeing their financial transactions” would be illegal.  If enacted, this article would be a revolutionary change in Iranian politico-economic affairs, given how easily previous governments siphoned off CBI resources to fund their costly pork-barrel projects, or worse, ordered the CBI printing machines to bail them out.

 Alls Not Fine

A further perusal of the document, however, reveals some surprising discrepancies. Article 14 designates as a “duty of the CBI” to act as the government’s agent when it comes to issuing bonds and securities. That, according to analysts, is step backward in the direction of promoting independence for the regulator because in most parts of the world that falls into the ambit of the economy ministry and not the central bank.  

Another positive provision, which prohibits the CBI from purchasing government bonds when first issued, is negatively offset by Article 2 that says it is for the CBI to “determine” the exchange rate for the rial against other currencies. Economists opine that this phenomenon would be considered an anomaly in advanced economies.

Another outrageous point in the bill is the old and tiring tale of appointing the CBI head, which still should be undertaken by the cabinet and ultimately approved by the president. Although the new bill curbs the power of the president in sacking the central bank chief, it still allows him to remove the him/her from office in the penultimate year of his tenure -- 5 years. Given that presidential terms are four years in Iran, this would mean that any new president can install a new CBI boss should the incumbent not see eye to eye with him.

Practice What You Preach

While the changes in the bill are praiseworthy, it still leaves much room to be desired. Indeed more is expected from the government of President Hassan Rouhani, which prides itself on its commitment to monetary and fiscal disciple and the rule of law. The government has a historic opportunity to leave behind a legacy by addressing this issue once and for all. It was through this very adherence to disciplined policymaking that it succeeded to bring down the inflation to single figures for the first time in three decades.

There are already worrying signs that this positive trend (less inflation) is in trouble. Broad money supply is surging again after declining considerably in 2014.And although the double-digit inflation has not showed up yet, it is likely that it would rear its ugly head again.

As a growing chorus of pundits sound the alarm for the government to get back to the basics of wise and workable decision-making, it is important for the government to also realize that it successors may not necessarily be big fans of monetary discipline.

In sum, it is only with the separation of fiscal and monetary policymaking enshrined in the sanctity of law that the rule of law can and must be guaranteed for generations to come.