Economy, Domestic Economy

Combination of Stimuli

Post-Doc and Teaching Fellow at Alzahra University
Combination of StimuliCombination of Stimuli

When recession hits hard, economists from different schools waste little time in demanding government intervention. Here, however, the neoclassical economists are the exception, as they believe government intervention has more costs than benefits.

During a recession, governments strive to increase spending or devalue their currency with the obvious aim of improving growth rates. The latter, advocated by monetarism, relies on the creation of money, while increase in government spending from borrowing and increasing government debt is the way of Keynesians.

Saddled with huge economic problems and recession brought on by both internal and external factors, the government in Tehran is about to implement a formidable combination of fiscal and monetary stimulus package. As a preemptive measure to prevent crisis and tamper inflation to a single digit, the package is a rather brave move. Not surprisingly, the stimulus has triggered a debate about the usefulness of such intervention from pundits across the political spectrum.

When assessing packages designed to rescue the economy, one thing that is of utmost importance is the need to minimize wastage of resources and improve efficiency. A majority of Iranians are proponents of less government and history has it that lack of trust in government intervention is a norm. However, the prevalent role of monetary policy played by a government preoccupied with budget deficits is rather misunderstood.

Firstly, we are not in crises mode with regard to deflation that calls for expansionary monetary policies. Second, the arguments against fiscal stimulus are not valid in the case of Iran, as future oil revenues can and should easily repay the relatively small public debt (12% of GDP) and the debt burden will not fall on taxpayers.  

In the recent financial crises, Australia had the shortest downturns among the developed economies and implemented one of the largest fiscal policy packages amounting to 4.6% of its 2008 GDP. The fiscal stimulus, in the form of handouts, was one-third of the whole package that increased consumer spending and augmented the recovery.

In fact, Canberra was an exception as its package had no bank bailouts. Hence, if fiscal stimulus helps increase consumer spending and boosts the Iranian economy, it can be considered a preventive measure vis-à-vis the threat of closures and bankruptcies leading to crisis.

It seems President Hassan Rouhani’s administration also has one eye on the relative success of quantitative easing after the financial crisis.

QE programs practiced by the US Federal Reserve, Bank of England, European Central Bank and Bank of Japan during the recent financial crises were a form of monetary intervention when interest rates are almost zero.  

While ECB and BOJ focused on direct lending to banks, the US Federal Reserve and BoE expanded their monetary bases by purchasing bonds and securities, a process that increased banks’ lending power and asset prices.

The recovery showed the relative success of QE programs. However, QE was heavily criticized by the diehard Austrian economists as a harbinger of inflation, which did not happen as it was designed to fight deflation. As the QE programs demonstrated the determination of central banks to fight deflation and unemployment, they led to a rebound in the confidence of investors and consumers.

However, it was believed that the US is prone to another crisis in the face of currency devaluation, which did not happen due to high global demand for the greenback and prolonged and healthy inflation. Anyhow, the continuous rounds of QE in the US has increased the size of the Fed balance sheet by a factor of 4, which is a sign of inflated assets while the economy is not in a good shape.

  Checks on Inflation

It should be noted that QE was implemented while interest rates were hitting the zero lower bound and governments were also dealing with the debt crises. Neither of these holds for the Iranian economy.

It has been emphasized that the Central Bank of Iran will monitor the effect of the monetary package on a regular basis and keep tight control on inflation. Part of the reason that the government wants to inject cash into the sputtering economy goes back to its success in taming the galloping inflation, which obviously was also influenced by international events and hence exceeded official expectations.

As such, it is believed that the cash injection will not have much of an inflationary pressure, as the people’s inflation expectation has apparently been adjusted. Moreover, given the decline in crude oil price, there would be a decrease in the growth of money supply that will be followed by a decrease in money demand due to relatively lower prices if and when the sanctions end.

The threat of new monetary package is that it fuels asset prices that might not lead to an increase in productive investment. While interest rate cuts encourage investment, the injected cash needs to be directed toward the manufacturing sector under government supervision. There is substantial precedent that it might result in dubious activities for misuse of financial incentives or overcapacities in some industries for receiving support.

If the present package leads to currency devaluation, it will also shift resources to markets with limited supply like land and art. This is because investors seek to hedge the risk of inflation tax and this is exactly what Iranian banks have been doing.

It seems the government is not much concerned about currency devaluation because its predecessor overcame the “fear barrier” in 2011 when the national currency lost almost 65% of its value in a matter of days. Currency devaluations are more often than not associated with unwritten rules that help exports and increase government revenues.  

If we assume that the monetary package leads to a 2% decrease in reserve requirements of banks, it will increase liquidity by 680 trillion rials ($22.7 billion). According to CBI estimates, every 1% reduction in the reserve requirements will increase liquidity by four percentage points.

This amounts to about 6% of GDP and hence the size of the package is quite big, out of which only about 2% constitute fiscal stimulus for completing development plans and repaying government debt to contractors.

The government debt repayment is not enough, according to Tahmasb Mazaheri, a former CBI chief who criticizes government incalculability and not the ballooning government debt. He has appealed for early and effective action from the government to repay its debts.

Anyway, success of the new plan will depend largely on how measures would reallocate resources and whether it will encourage consumer spending within reasonable inflation rates, for which preventative measures seem to be in place, as indicated by the central bank.