Economy, Domestic Economy

Fiscal Discipline Before Inflation Targeting

Fiscal Discipline Before Inflation Targeting Fiscal Discipline Before Inflation Targeting

Iran needs to implement fiscal frameworks and inflation targeting to attain higher growth rates while keeping prices stable, according to a recent report published by the Central Bank of Iran's research arm.

To get optimal results from these policies, the government must adopt fiscal rules—frameworks to constrain the government's tax and spending behavior by the assessment of independent arbiters—before curbing inflation via its monetary tools, e.g. interest rates, reserve requirement and money printing, the Monetary and Banking Institute's study suggests.

The report draws upon research in six international papers to arrive at its conclusions and offers three broad guidelines for bringing fiscal frameworks and inflation curbs into force.

> Long History of Fiscal Dominance

Iran has long suffered from weak checks and balances on the government's fiscal powers and its rule over monetary policy. Petrodollars and printed money have on average paid for over 70% of the government's expenditures in the past, destabilizing the economy even during growth periods.

Without any long-term strategic planning and accountability, windfall oil revenues were spent cyclically—in accordance with the economic cycle—meaning oil money was spent lavishly and based on political considerations, adding to economic booms but also creating runaway inflation.

During low crude oil price periods, the government resorted to printing money and borrowing from banks to cover fiscal gaps, leading to volatile and drastic price increases.

"Iran's economic condition is such that the government and its policies have overshadowed other sectors and fiscal dominance is evident in its economy," the report reads.

The CBI has always acted in accordance with the wishes of the government and sacrificed monetary policy at the whim of the government.

The bank's little independence was further eroded by former president Mahmoud Ahmadinejad, but that trend has been reversed by President Hassan Rouhani's administration, which is even talking of an independent central bank.

> Fiscal Frameworks

Fiscal rules–first researched in the 80s to create fiscal stability, limit the effect of politics in fiscal spending, keep the government small and limit cyclical fiscal spending patterns—are the centerpiece of creating stable economic growth, the study suggests.

"Disorganized fiscal policies and increasing government debt affect inflation by disrupting monetary policy. Lack of appropriate fiscal frameworks leads to permanent dominance of fiscal policy over monetary policy."

The report's review of six research papers reveals that countries that implemented fiscal frameworks before Inflation Targeting achieved greater economic success, compared to countries that tried the other way round or just reinforced monetary or fiscal rules.

Iran as a commodity exporter needs "expenditure rule" and "balance budget rule" to limit economic instability.

The National Development Fund of Iran—a sovereign wealth fund created to invest oil revenues for future generations—was set up to help with fiscal discipline, but money withdrawal regulations need to be clearer, as governments have used its funds to cover fiscal gaps.

> Inflation Targeting

Inflation Targeting should come after fiscal frameworks have been established. Its implementation also requires an expansion of Iran's money markets, additions to central bank's tools and the lifting of economic sanctions leveled against the central bank by the West over Tehran's nuclear energy program.

Furthermore, the study suggests a five-year period in which inflation targeting is introduced in three stages.

At the end, the report reminds fiscal and monetary officials that adopting fiscal frameworks and Inflation Targeting is a win-win game for both parties.