Monetary economy
Rana Abbasgholi Nezhad Asbaghi; Hosein Samsami
Abstract
Some monetary policymakers attribute the persistent high inflation in Iran’s economy solely to the lack of central bank independence, arguing that granting the central bank autonomy is necessary to reduce inflation. However, empirical studies reveal that central bank independence faces significant ...
Read More
Some monetary policymakers attribute the persistent high inflation in Iran’s economy solely to the lack of central bank independence, arguing that granting the central bank autonomy is necessary to reduce inflation. However, empirical studies reveal that central bank independence faces significant structural challenges due to the endogeneity of money within Iran’s economic system. This article aimed to identify the key components of requirements of central bank independence, with a particular focus on the government structure in Iran’s economy. A comprehensive review of existing literature on central bank independence was conducted. Moreover, a grounded theory approach was used to achieve theoretical saturation concerning central bank independence in Iran. Then, the study relied on the Bayesian model averaging (BMA) and analyzed 21 variables to identify the key factors defining the requirements of central bank independence in Iran. The findings highlighted several key factors, including the deviation of the effective exchange rate from the appropriate exchange rate, the government budget deficit, oil revenues, and the government effectiveness index. Furthermore, the results suggested that increasing central bank independence alone, within the context of variables contributing to endogeneity of money under Iran’s current economic conditions, has a weak and fragile effect. Thus, it is essential to undertake structural reforms targeting these critical variables as a prerequisite to meaningful discussions and efforts toward central bank independence.IntroductionThe theory of time inconsistency proposed by Kydland and Prescott (1977) posits that central bank independence can reduce inflation rates without incurring economic costs while enhancing stability by lowering inflationary expectations. However, several empirical studies (e.g., Bauman et al., 2021) emphasize that the effectiveness of central bank independence depends on the unique structural and institutional characteristics of each country. As a result, central bank independence is not a universal solution and may vary depending on the specific structural conditions of each economy. The relationship between central bank independence and inflation rates can significantly differ when structural and institutional factors deviate from the ideal. Iran’s economy has recently undergone substantial fluctuations in inflation rates. Some monetary policymakers attribute these high inflation levels solely to the lack of central bank independence, asserting that greater independence is necessary to control inflation. However, structural factors unique to Iran’s economy complicate this view. Issues such as an inefficient tax system, reliance on oil revenues, underdeveloped financial markets, exchange rate markets, and the quality of governance indicate that money is largely determined endogenously. These structural challenges undermine the effective implementation of central bank independence as a tool to reduce inflation and promote economic growth. Given these complexities, the present study sought to identify the key components necessary for central bank independence within Iran’s economic system. Focusing on the government structure, the study employed a grounded theory approach and Bayesian model averaging (BMA) to identify the requirements for central bank independence in Iran.Materials and MethodsThis research identified categories related to central bank independence by reviewing the existing literature. It used a grounded theory approach to achieve theoretical saturation. As a result, four key categories were identified: the exchange rate market, the government budgeting system, the quality of governance, and the central bank independence. Specific variables were analyzed within each subcategory to uncover the robust components influencing central bank independence in Iran’s economy. To collect data for the analysis, the study used reliable sources, including databases from the Central Bank of Iran, the Statistical Center of Iran, and the World Bank. The concept of central bank independence was treated as a dependent variable, consistent with the methodology proposed by Giannone et al. (2011) and informed by studies such as Rogoff (2019) and Baumann et al. (2021). These studies define the concept in terms of liquidity under optimal conditions. The variables were tested for their significance and intensity of influence on the dependent variable, allowing for the identification of those that retained their effects even when other variables were included in the model.Results and DiscussionThe results presented in Table 1 are based on coefficient calculations and posterior probabilities from 340,000 regressions. They helped identify four variables as statistically robust and non-fragile even when accounting for the presence of all other variables. These variables included the deviation of the effective exchange rate from the appropriate exchange rate, the government budget deficit, oil revenues, and the government effectiveness index. The result is supported by their posterior probabilities, which exceed the prior probability threshold of 50%, as assumed under the uniform distribution in the Bayesian model selection (BMS) method.Table 1. The Results of the Sampling Process and BMS Estimation Calculations based on 340 Thousand RegressionsA proportion of regressions withCond. Pos. SignPost SDPost MeanPIPSymbol 0.9910.09870.54240.9999DEA10.9710.14890.50730.9880BDG20.9110.03950.11060.9417GOR30.8500.0554-0.10400.8832EFG40.610.99990.03890.02360.3293COC50.580.01981.0681-0.57120.2869RET60.560.88091.05530.56240.2839REO70.560.92340.25230.13440.2786REG80.280.89960.00480.00110.1355BAC90.250.09150.0733-0.01200.1247CUK100.210.14430.0777-0.00510.1219MAT110.200.28310.0411-0.00080.0970GRI120.180.35270.0634-0.00590.0899DUM130.190.86900.00650.00130.0890UR140.170.99800.00310.00070.0875EC150.150.21920.1140-0.00740.0805TINF160.140.49550.0148-0.00150.0787ECI170.150.15390.0088-0.00120.0676RLA180.130.12760.0179-0.00210.0610DECM190.120.83750.00550.00060.0594HI200.090.90910.00340.00030.0549UNC21* Source: Research resultsThe weighted average of posterior coefficients further revealed that the variable representing the deviation of the effective exchange rate from the appropriate exchange rate is the most influential in the model, exerting the strongest positive effect in terms of intensity. Following this, the government budget deficit, oil revenues, and the government effectiveness index ranked as the next most significant variables, respectively, based on their influence coefficients. Yet, the results indicated that in the presence of all variables, central bank independence indices (i.e., GRI, CUK, MAT, and DUM) are fragile and statistically insignificant. This is due to their lower posterior probabilities of inclusion compared to the prior probability, underscoring their limited relevance within the model.ConclusionSince central bank independence indices lose significance when the four key components are considered, simply enhancing central bank independence is not a viable long-term solution under the current conditions of Iran’s economy characterized by the endogeneity of money. Therefore, during the transition phase, policymakers must prioritize structural reforms in several key areas: reforming the government budgeting system, improving governance with a focus on efficiency and effectiveness, and developing a competitive foreign exchange market capable of establishing an optimal and efficient exchange rate. Only after addressing these foundational issues should efforts to enhance central bank independence proceed, supported by a robust legal framework and coordinated collaboration with the government.
Monetary economy
Hossein Samsami; Parviz Davoodi; Rana Abbasgholi Nezhad Asbaghi
Abstract
One of the factors that change the results of the expansionary monetary policy through the credit channel on the economy is the financial frictions that affected Iran's economy especially in the 2002’s and 2022’s. These frictions are manifested in variables such as capital adequacy violations, ...
Read More
One of the factors that change the results of the expansionary monetary policy through the credit channel on the economy is the financial frictions that affected Iran's economy especially in the 2002’s and 2022’s. These frictions are manifested in variables such as capital adequacy violations, the ratio of nonperforming loans, the ratio of fixed assets to the total assets of banks, and the government's net debt to banks. In this article, with the help of building a macro structural econometric model in the period of 1968-2022, the effect of expansionary monetary policy on the change of each type of financial friction has been investigated and compared with emphasis on the endogeneity of money on Iran's economy. The obtained results show that due to the endogeneity of money, the influence of the central bank's monetary policy on the real sector of the economy has decreased and most of its effect is manifested in nominal variables such as liquidity, inflation rate and exchange rate. In addition, an increase of one standard deviation in the ratio of nonperforming loans reduces the impact of the expansionary monetary policy on the real sector of the economy more than other mentioned financial frictions. After that, the decrease in capital adequacy, the increase in the government's net debt to banks, and the increase in the ratio of fixed assets to total assets are in the next level of importance of reducing the effectiveness of monetary policy.1.IntroductionIran’s economy heavily relies on banks to finance economic entities, emphasizing the crucial impact of monetary policy through the credit channel. However, the effectiveness of monetary policy on the real sector of economy can be impeded by financial frictions. These frictions intervene in financial transactions and may increase the costs associated with obtaining external financing, such as loans, for investors (Farzinvash et al., 2014). Empirical evidence suggests that, despite high liquidity, Iran’s economy has encountered a credit crunch, especially during the period spanning from 2002 to 2022. This credit crunch can be attributed to violations of prudential ratios, including capital adequacy, nonperforming loan ratio, fixed asset ratios to total bank assets, and the government’s net debt to banks.As a consequence of these frictions, banks face resource shortages and resort to borrowing from the Central Bank through overdrafts. This results in an expansion of the monetary base, subsequently increasing liquidity and leading to a rise in the general price level. Consequently, owing to the endogeneity of money in Iran’s economy, the Central Bank lacks an independent monetary policy instrument to effectively achieve its goals. The impact of liquidity on the real sector of economy is limited, with most impact observed in nominal variables and manifested as price increases.In this respect, the present study aims to examine the impact of financial frictions on the effectiveness of expansionary monetary policy through the credit channel, specifically focusing on the endogeneity of money. Additionally, it tries to compare the respective effects of the frictions on the Iranian economy. The analytical perspective ensures the distinctive and innovative aspect of the study.2.Materials and MethodsConcerning the period from 1968 to 2022, a large-scale macroeconometric model was developed based on aggregate supply–aggregate demand frameworks and national income accounting. The research model encompasses various components, including consumption and investment expenditures, government activities, foreign trade, production, money and credit, general price levels, exchange rates, and the balance of payments. Data for constructing the model was sourced from the Central Bank’s Time Series Data Bank, the Central Bank’s balance sheet, (non-)governmental banks balance sheets, the Statistical Centre of Iran, and the World Bank.The model consisted of 28 behavioral equations, 9 connecting equations, and 91 identities. Auto-Regressive Distributed Lag (ARDL) method was used to estimate the model equations, and all equations were concurrently solved through dynamic simulation. The study relied on the criteria such as Root Mean Square Percentage Error (RMSPE) and the Theil index of inequality (U) to test the model’s performance.3.Results and DiscussionIn order to investigate the influence of individual financial frictions on the impact of expansionary monetary policy on Iran’s economy, the study assumed an annual one standard deviation increase in bank debt to the central bank as a monetary policy instrument in each considered scenario. The scenario development period spans five years, from 2018 to 2022, where the baseline trend represents the state of implementing solely expansionary monetary policy while keeping all types of financial frictions invariable in the current state of Iran’s economy.Moreover, in case of one standard deviation alteration in each financial friction during the implementation of expansionary monetary policy, it can be used to classify capital adequacy, nonperforming loans ratio, the government’s net debt to banks, and fixed asset ratios to total bank assets in the scenarios 1, 2, 3, and 4, respectively (see Table 1). Table 1. The average percentage deviation of the simulated values of the important endogenous variables in the examined scenarios from the base simulated values during the period 2018–2022Scenario 4:Increase in the fixed asset ratios to total bank assetsScenario 3:Increase in the government’s net debt to banksScenario 2:Increase in the nonperforming loan ratio Scenario 1:Reduction in capital adequacy of banksVariables-18.63-23.33-24.9-22.13Depth of bank credits-3.16-3.25-3.22-2.86Production capacity utilization rate-5.14-6.14-6.38-5.96Investment-1.82-2.3-2.4-2.24Employment-1.94-2.26-2.36-2.39Total factor productivity-2.84-3.2-3.3-3.23Gross domestic product-3.1-3.49-3.6-3.52Non-oil gross domestic product12.8913.8413.8414.19Changes in inventories19.3731.4235.4236.24Liquidity3.15.185.935.81Inflation rate7.3312.4414.1114.36Exchange rate* Source: Research resultsTable 1 illustrates that the impact of expansionary monetary policy varies across different scenarios examined. Scenario 2 (i.e., the increased ratio of nonperforming loans) impacts both the real and nominal sectors of economy by causing more significant fluctuations in these variables compared to the baseline simulation. Scenarios 1, 3, and 4 hold subsequent degrees of importance in diminishing the effectiveness of monetary policy.4.ConclusionBased on the findings, it can be concluded that the effectiveness of expansionary monetary policy on the real economy weakens the most when the nonperforming loan ratio increases, compared to three other financial friction indicators. Therefore, to mitigate nonperforming loans in banks, the study suggests that economic policymakers focus on controlling inflation rates, exchange rates, fluctuations in gross domestic product, and fluctuations in investment in the real estate sector. The priority should also be given to monitoring the decline in the quality of bank management due to the increase in the ratio of bank credit balance to total volume deposits after deducting the legal reserves. It is also worth noting that the proper implementation of Islamic contracts by banks can significantly contribute to reducing nonperforming loans.
Hossein Samsami; Habib Nemati
Abstract
The vulnerability of Iranian economy to various shocks has attracted attention to economic resilience. In this regard, foreign trade, which is inherently more exposed to shocks, merits careful consideration. In order to examine the effects of imports on economic resilience, a small-scale macroeconometric ...
Read More
The vulnerability of Iranian economy to various shocks has attracted attention to economic resilience. In this regard, foreign trade, which is inherently more exposed to shocks, merits careful consideration. In order to examine the effects of imports on economic resilience, a small-scale macroeconometric model has been specified. Having solved the model and run simulations, the effects of shocks stemming from imports on GDP is measured. This study, for the first time, quantifies the concept of resilience by examining the implications of economic shocks in a large-scale macro-econometric model. Accordingly, the modeled system received three types of shocks caused by the imports of consumer, intermediate, and capital goods. Then, the magnitude of their effects on GDP as well as the pace in which the variables back to their equilibrium are analyzed. The results demonstrate that the shocks coming from intermediate goods have the most severe consequences and threaten Iranian economy severely.
