 |
We must
note that there is always a justifiable
gap between inflation and
liquidity, which can be justified in view of economic growth and increased
volume of imports. |
|
A Short Dream for Liquidity |
The gap between liquidity and
inflation rate has always been an interesting riddle for monetary officials of
our country, which has been also noticed by the Central Bank of Iran. In
simple terms, the main question is how, when growth rate for liquidity is
above 30 percent, inflation in the Iranian economy stands at about 12-13
percent?
There are several possible answers
all of which have been studied by officials of the Central Bank of Iran.
Possible explanations include error in estimating inflation rate on the basis
of CPI (consumer price index), economic growth, growth of exchange market in
Iran at a time when there is a tangible gap between liquidity and inflation,
capital flight, excessive imports and so on.
However, the imminent threat to the
Iranian economy is how to fill this gap. Due to the following reasons, such a
wide gap between liquidity and inflation cannot be continued over long-term
and only a logical level of such a gap, which is dependent on several factors,
can exist in Iran’s economic environment.
Undoubtedly, in the long run,
growth of liquidity along with rapid growth in money turnover will be equal to
inflation and economic growth rate and this is the result of Fisher equation,
which is still being accepted many years after it was presented. Changes in
the speed of money turnover in the long run require personal preferences more
than anything else and, for this reason; this growth is considered to be equal
to zero in textbooks. Therefore, growth of liquidity is practically taken to
be equal to economic growth and inflation rates.
Even in this case, we cannot claim
that money turnover should, in the most optimistic state, be reduced by 5
percent to be able to cover part of the gap between inflation and growth of
liquidity. Its current fall as a result of reduction in expected inflation.
So, just on the threshold of association between inflation and growth of
liquidity, expected inflation has automatically increased and demand for
depositing money has seriously decreased. As a result, money turnover
increases and is ensued with special inflationary consequences.
On the other hand, economic growth
cannot justify the existing gas between inflation and liquidity. Therefore, it
seems that all burden of increased liquidity is imposed on inflation and if
its effects do not show up in the near future, it will lead to excessive
inflation in the long run; but when?
Just during the first oil shock
(reduced prices) when the inefficient state structure has gotten used to high
oil prices, with the first shock, not only budget deficit will lead to high
growth of liquidity in the same year, but dormant liquidity will also become
active.
Now, let’s have a closer look at
that difficult day. Reduced oil prices will lead to budget deficit and growth
of liquidity, which will be quite different from early projections and will be
totally due to borrowing from Central Bank of Iran. On the other hand, all
alternatives that were previously available to the government to keep rising
inflation in check will be lost. In better words, ability of the bank for
stabilizing foreign exchange rate will decrease and, therefore, purchasing
power for imports will be reduced, on the one side, and price of foreign goods
will be increased, on the other side. Thus, inflation will rise further.
As a result of such stagnation, the
exchange market will not be able to absorb liquidity and inflation will fan
the flames of inflationary expectations so severely that demand for depositing
money will reach zero. Therefore, money turnover will take on more speed and
this will worsen inflation. At that time, we cannot think about the gap
between inflation and liquidity and we can even claim that the gap will be
reversed with inflation overtaking liquidity and this phenomenon will occur
under those conditions.
We must, however, note that there
is always a justifiable gap between inflation and liquidity, which can be
justified in view of economic growth and increased volume of imports. This gap
will not longer represent dormant liquidity because increased liquidity has
increased production of goods and services in the society and, therefore,
growth of liquidity has, to some extent, contributed to inflation while the
rest of it has been evenly distributed over those factors.
On the other hand, officials of the
Central Bank of Iran have rightfully pointed to effect of goods on CPI and
their lower price growth compared to other items such as services and housing.
The point, however, is that due to arbitrage among markets in the long term,
price increase of such goods will outdo other goods and, at that time,
inflation rate will be higher due to correction of CPI. Of course, the
correction may not be exactly simultaneous with other factors.
All these alternatives are sure to
happen during the first oil shock. Although, it is possible that as a result
of excessive expansionary policies to be adopted by the government and
expectation from banks to help it and due to lack of independence of the
Central Bank of Iran, dormant liquidity will become active earlier than
expected. Are we ready for such a difficult day? |
