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October 2018, No. 89


Viewpoint

Mr. President,
Do Not Discount the Economics!


I voted for you at the time of the elections, and I still consider you as a person with good intentions in the turbulent world of politics.


Dr. Hassan Dargahi, an economist, has sent an open letter to Dr. Hassan Rouhani in which he has presented his solutions to bring the economy out of the status quo.

In the introduction of the letter, Dr. Dargahi says: “Based on my religious and scientific conscience as well as the need for observing professional ethics, I decided to write directly to you concerning the critical state of the economy and discuss my proposed framework for coming out of the status quo. One of the hopes created by the ‘government of foresight and hope’ was attention to the scientific management of the economy in coordination with the university elites and private sector activists, but the administration of the economy was practically left to the intellectual management of individuals who neither paid attention to the economics nor did they learn from the experiences of the past in the area of economy.

“Look at the current state of economic affairs and see how the external elements took control of the domestic economic problems you had five years to resolve, and how instability was escalated. Nonetheless, the government’s unscientific policy making methods in dealing with the recent instability led to more uncertainty. This writing does not intend to question the quality of government policy making unilaterally because the government is only part of the economic decision-making and economic management system of the country and it would be fair to distinguish the share of government and non-government in elucidation of the root causes of economic problems, as well as the contribution of domestic and foreign policies. Under the current state of incredulity in the country, please consider this writing from an academic economist who has no political and economic goals, left or right, and who merely has good intentions for the government and the establishment. I voted for you at the time of the elections, and I still consider you as a person with good intentions in the turbulent world of politics.”


Mr. President! You cannot ignore the knowledge of the economy. Economic knowledge helps understand the dynamics and interaction of mechanisms and explanation of economic behaviors at micro and macro levels.


The necessity of internal coordination of the government, the need for coordinating the government with other elements of the establishment and the importance of recognizing economic mechanisms and scientific approaches are among the main points raised in this letter.

Dr. Dargahi believes that the existence of inconsistencies has prevented the government from reaching a single scientific analysis on the causes of the economic problems and, consequently on the solutions. “Otherwise, the results of the comprehensive economic studies project under the auspices of your Special Economic Assistant, published in 1396 (2017/18) could at least be a good guide to the current state of the economy. Differences in the analysis of economic problems with different motives and the implementation of contradictory strategies have led to no results but to discredit the government, leading to policy changes and, consequently, an increase in instability.”

Please review the government’s expansionary and contractionary economic policies during the recession of 1392 (2013/14), the important reason for which was a lack of clear elucidation of the problems and solutions based on the scientific management of the economy. For example, your economic team did not agree on expansion or contraction of the monetary policies, decrease or increase in banking interest rates, and how to manage exchange rates. Just take a look at the intensity of the foreign currency policy changes over the past three months and count the number of its directives and decrees. Do you think that theoretical and empirical knowledge of the economy is so unreliable that it cannot detect the time of expansionary or contractionary monetary policies? Or is it so incapable of offering a solution to the desired foreign exchange system in different circumstances? If we add the political pressures outside the government to the inconsistencies inside the government, then the economic progress of your government has been a source of serious concern from the start. Therefore, to strengthen the coordination of economic organizations in order to explain the problems and find solutions in the framework of scientific management, rather than individuals being important, the existence of similar approaches and paradigms based on economics is important, otherwise the change of individuals would not be effective.

In compliance with improvement of the economic governance of the country, I sent a proposal to you about 3 years ago through the presidential chief of staff, which I was not even told if it had been acknowledged. Since then, I have mentioned the theoretical and empirical foundations of my proposal in various writings, including “Improving Economic Governance in Iran’s Political Structure: An Analysis on Coming out of Economic Problems”. In my proposed system, a strong, intelligent, influential and supervisory council for managing the development, implementation, and monitoring of the economic reform program is formed to utilize the upcoming opportunities, and potential capabilities for achieving employment generating as well as sustainable, introversion and extraversion economic growth. The council assumes the responsibility of promoting the coordination of the economic decision-making system of the country in relation to the staff, executive as well as governmental and non-governmental decision-making centers, the private sector, economists and economic activists. One of the important tasks of the council should be to eliminate the political-economic obstacles and challenges in the country in order to achieve the projected goals of key economic indicators and to present the legal requirements of the reform program to the three powers.

The said council would present the effectiveness of its actions every three months to the Supreme Leader to receive his guidelines in order to solve the problems of the government and eliminate the clash of interests between different political groups and institutions. Unfortunately, these proposals were not accepted until recently that the Supreme Economic Coordination Council of the three powers was formed. So this time the government should not miss the opportunity. If you do not use this capacity and the mechanism created in the area of trans-governmental ​​decision-making and coordination, the ball of economic problems would always be in government court and radical groups would hold the government responsible for all the problems. This would also overshadow the next presidential elections. By creating this council, a new opportunity has been created to improve the economic governance in the country in order to promote national interests, although its structure needs to be revised and completed.


Look at the current state of economic affairs and see how the external elements took control of the domestic economic problems you had five years to resolve, and how instability was escalated.


In order to make the council more efficient, three important reviews in terms of decision making, empowerment and oversight should be made. Firstly, in the area of ​​decision-making, the council’s relationship with the scientific elites and private sector players should be defined effectively and systematically. Secondly, this council should have the power to make key economic decisions centrally, despite the differences between groups based on the definition of red lines. Thirdly, by designing a monitoring system, the implementation of council’s decisions in the executive branches of the country should be controlled. The important thing is that there is no mechanism in place of the existing decision-making system to balance optimally between the political and socio-economic objectives of the country. Because of the interdependence of economy and politics, these two areas can not be independently targeted. The council can play this important role by monitoring important socio-economic indicators and, with a realistic explanation of the requirements, play a decisive role in defining the roadmap for progress. Therefore, in the first step, the structure and decision-making processes of the council should be designed in line with the above objectives.

Mr. President! You cannot ignore the knowledge of the economy. Economic knowledge helps understand the dynamics and interaction of mechanisms and explanation of economic behaviors at micro and macro levels. Without this knowledge and by relying on imagination and intuition, policy making cannot be done. Believe me that the knowledge that has been a necessary condition for development and progress for others is incidentally more effective in terms of Iran’s cultural and social capitals and can make the investments fruitful. This knowledge, like other human sciences, such as medical and engineering sciences adds to its previous reserves by discovering behavioral truths overtime. But certain currents in the country from the beginning denied the capability of the analytical tools of economics! Please show us economic complications that have been solved by this inattentiveness.

For simple minds it is hard and at the same time surprising to see that the country has always been in a state of inflation over the last forty years, while in many countries there is no such thing as inflation. Inflation is an economic phenomenon; it has economic cause and demands economic solution. In order to combat inflation in the Iranian economy, all sorts of policies were tested except for the implementation of the monetary control framework directed at controlling inflation, as suggested by economics.

Prescribed pricing method for various goods and even foreign exchange, bank interest rates, and the price of energy carriers became part of the economic literature as a dominant and continuous policy. This was to the extent that instead of providing an effective and efficient social security system, the governments tied assistance to consumers, improvement of income distribution and social justice to this policy.

If the prescribed pricing was supposed to check the inflation then rest assured that Iran’s experience would have been published in economics textbooks at the world level but according to statistical evidence this did not happen! Inflation was not only not controlled but was constantly blown up over the root of inflation, namely money plus. Not only income distribution and social justice were not improved, but the disruptions in relative prices became factors of deviation in allocation of resources and inappropriate decisions on production, investment, consumption, savings and trade at the macro level.

A few empirical studies about different countries, including Iran, should be conducted to make our statesmen understand the role of money in inflation so that we would realize that the money surplus reduces the value and the purchasing power of money, according to the business cycles and expectations of the people, and this shows itself in rising prices.

The surplus money supply, especially during your reign, has grown dramatically. In such a situation, the private sector’s demand from the consumption and investment channel is expected to increase. But the 11th government was faced with a state of recession, where neither households had incomes to consume nor businesses were able or willing to make new investments. As a result, total demand in the economy did not increase the result of which was low inflation despite strong liquidity growth. Therefore, do not give the credit for the drop in inflation rate of this period to the monetary policies of the Central Bank of Iran. Although the CBI, within the limits of its powers and instruments, tried to organize the monetary market, the monetary policy was not focused on controlling inflation. Another question is that why there was stability in financial markets such as the foreign exchange market? The stability factor was the hope that came about as your government came to power, which reduced the inflationary expectations of the community.

The abovementioned factors, in particular, the decline in the rate of return on activities and expected inflation, led to a slowdown in the flow of money, indicating a weakening of the relationship between liquidity and inflation and an increase in demand for money in the short run. This same mechanism occurred under the 10th government when we had an abundance of oil revenues because high foreign exchange earnings, combined with artificial appreciation of the real exchange rate, led to a sharp increase in imports and a reduction in expected inflation and the rate of return on domestic production.

In conditions of a slowdown in money flow (rising demand for money), politicians push for increased money supply, without fear of inflation, and simply with political attitudes and in the hope of generating output and employment. The question now is how does this faulty circle correct itself? Change in people’s expectations about the country’s future conditions and creation of inflationary expectations, for example, because of the US withdrawal from the JCPOA, even without changing the economic variables, will lead to an increase in the rate of money flow and boost the relationship between money and inflation and reduce demand for money. Although this situation shows its gradual effects on the product market, in the short term, the financial markets, such as the forex market, are subject to severe instability. In other words, the real effects of surplus supply of money are reflected in the prices of different markets.

The role of expectations from the future of the economy in the current decisions of economic agents is one of the important macroeconomic issues that have been applied in macroeconomic analyses since the 1980s. The issue of the effectiveness of government policy has also been seriously challenged by raising the question of expectations. Given the role of expectations, the government is not the only actor in the realm of economics, but it is faced with a response from economic agents for every policy it adopts. In such a situation, the credibility of the government’s policy for market stabilization is crucial; otherwise, the people’s minds based on any set of information about the past, present and future become the basis of economic decisions that may not be consistent with the stabilization goal of the government.
Unfortunately, you and other officials in the analysis of the recent foreign currency crisis, regardless of the key role of expectations, have consistently talked about detraction in the forex market and were astonished to see the exchange rates rising dramatically without changes in economic variables such as the trade balance. You even called the open market exchange rate, not informal exchange rate, but the street corner rates. You firmly set the official rate of the US dollar at 42,000 rials and insisted on it but noticed its ineffectiveness very quickly. The reason for criticizing the policy of fixing the exchange rate on a false figure and creating a rent for rent seekers and the waste of national resources and capital does not mean defending those disrupting the market. No one denies fighting the profiteers engaged in the big currency and gold coin trading, whether for economic or political purposes or creating turmoil in the market.

As a matter of fact, the occurrence of such events indicates a weakness in regulatory, banking and taxation laws. This phenomenon should be distinguished from the open market behavior of the foreign currency. What has happened to the government’s expert body that you should hear exchange policy recommendations from different tribunes? Don’t you think all these changes in the forex policy and the daily publication of various directives to compensate for the consequences of adopting a false exchange rate policy will discredit the government? Rest assured that there is no possibility of controlling exchange rate rent seeking. The current situation is the result of intense expansionary monetary policies coupled with the suppression of the exchange rate in the environment of business uncertainty. A jump in the exchange rate in the Iranian economy was not far from expectation due to the long-term decline in the real exchange rate over the past years. This issue for the umpteen time should serve as a useful lesson and experience for the government in its monetary and foreign currency policies in the future.

But in the current situation, we must accept the reality of devaluation of the national currency and the rise in prices in the markets and adopt an appropriate policy to minimize the costs because its denial and adopting non-economic policies in resolving the crisis have caused more instability in the markets so far. It is suggested that in the light of the status quo and what is expected until the completion of the unilateral US sanctions and the possible reduction of oil revenues a dual currency system, including a rate for import of commodities and an open market rate, be recognized. What is a source of concern is the decline in the purchasing power of low-income groups and restrictions on access to basic goods that can be allocated at the exchange rate set by the CBI with the oil money. Other foreign exchange needs can be supplied from the hard currency from oil and non-oil exports in the open market.
Dr. Dargahi says at the end of his letter: “Mr. President the monetary base and reforms favored by the banking system should be given priority. Also unnecessary pricing under the pretext of preventing inflation should be banned as in these conditions production coupled with inflation is preferable to stagnation and unemployment. It is hoped that in the future, after relative stability is established in the political situation, the foreign exchange subsidy to the basic goods would be converted into targeted local currency subsidies and the single exchange rate would be based on a floating exchange management system. In this case, the amount of government subsidies in the budget would be transparent, and it would be possible to target it in different circumstances in the future. More importantly, the ground for emergence of export concessions would be created and the domestic production capacity would be boosted in the light of logical import controls.

 

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  October 2018
No. 89