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The
Liquidity Puzzle
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Total liabilities of banks
with the Central Bank of Iran have increased from 28 percent of their
legal deposits to 103 percent of those deposits in 2008.
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Despite
the fact that total volume of liquidity in Iran has increased from 92 trillion
tomans in 2005 to 190 trillion tomans in 2008, registering a more than twofold
rise, shortage of liquidity is one of the most important problems facing
businesspeople. How this riddle can be solved and what practical conclusions
may follow? The first and simplest explanation is low price. That is, when
price of a commodity decreases, demand for that commodity goes up and if the
market were not able to create a balance, early abundance would be soon
followed by scarcity. Of course, money market is more complicated than that of
ordinary goods but the same logic governs both markets.
A hundred
percent increase in nominal volume of liquidity during the past few years has
stood in stark contrast to the fact that real economic growth in the same
period according to the most optimistic estimates has been less than 30
percent. This means that the volume of liquidity has increased 70 percent more
than the actual need of domestic economy in the same period and this
phenomenon can lead to a similar degree of inflation.
When
inflation rises, the purchasing power falls. Therefore, demand for money is
always proportionate to its real purchasing power, not its nominal value.
Since oversupply of money by banks leads to inflation and inflation reduces
purchasing power of the money, one may claim that increased supply of money is
a mechanism which will finally lead to scarcity of real money. This is the
main feature of the money market where nominal oversupply of cash in
short-term can meet the demand for money, but in the long-term, it reduces
purchasing power due to increase in inflation, thus, worsening shortage of
liquidity. Therefore, cash supply is not the best solution because it leads to
a vicious circle in which apparent treatment will complicate the disease.
The real
way to fight inflation is through suitable financial and monetary policies.
Chronic and remarkable budget deficit accompanied by lack of discipline in the
financial system are major factors fostering inflation in countries like Iran.
The main party to blame is the central bank and its monetary policies because
it is in charge of discipline in financial system and maintaining the exchange
value of money.
Unfortunately, due to certain reasons, legal deposits with the central bank
provide it with the sole mechanism to establish discipline in the money
market. However, a glance at those deposits in recent years will show that
even this controlling tool has gotten out of hand. Legal deposits with banks
stood at about 13 trillion tomans in 2005, which increased to about 22.5
trillion tomans in 2008. During the same period, liabilities of banks with the
Central Bank of Iran increased from about 3.6 trillion tomans to 23 trillion
tomans. In other words, total liabilities of banks with the Central Bank of
Iran have increased from 28 percent of their legal deposits to 103 percent of
those deposits in 2008. This means that deposits are no more capable of
controlling liquidity. It follows that administrative orders for expanding
credits have practically replaced monetary policies and the central bank is
practically unable to enforce monetary policies.
If we
accepted that controlling inflation is the most immediate step to correct the
current situation in the money market and admitted that the Central Bank of
Iran is the main authority to do that, then necessary steps should be taken to
restore the needed tools for the enforcement of the central bank’s monetary
policies. A feeble central bank stripped of authority would not be able to cut
the Gordian knot of the currently confused money market. |
