Consequences of Interest Rate Suppression in Iran’s Economy

Consequences of Interest Rate Suppression in Iran’s Economy

Why Inflation in Iran Is Not Being Controlled

According to Iran Gate, many economists are questioning why the Central Bank of Iran resists using the interest rate channel to control inflation. Meanwhile, world economic powers, in light of the rising trend of inflation over the past year, have promptly increased interest rates and, indeed, have achieved significant and positive results in controlling inflation.

Recently, the world’s largest economies have faced significant and even unprecedented inflationary surges. This phenomenon, which began in the U.S. and many European powers around mid-2021, has compelled central banks in these countries to use monetary tools to control inflation. For a little over a year, the U.S. Federal Reserve has had to use these tools, despite dissatisfaction from wealth centers in the world’s largest economy, to control inflation. The important point is that these actions by the U.S. Federal Reserve have been effective, significantly and meaningfully curbing inflation.

The Golden Tool for Controlling Inflation

The term ‘inflation’ is likely the most frequently used economic term that people refer to in their everyday conversations. The public perceives inflation as synonymous with high prices, rising costs, or reduced purchasing power. In short, inflation growth means a decrease in the national currency’s value, which subsequently causes price tensions in the market or, in other words, the rising cost of goods and services.

Economists believe that to stop the upward trend of inflation, or in other words, the process of declining national currency value, measures must be taken to strengthen the monetary foundation. According to the vast majority of experts, since inflation is a monetary phenomenon, monetary tools must be used to control it. Otherwise, any action will either have temporary and palliative effects or result in the opposite, with policymakers facing increased inflation after a short delay.

Thus, it is said that the interest rate channel is the best tool for controlling inflation over a specific and short period. This tool essentially represents the value of money and can restore balance to monetary exchanges in the country. In other words, increasing the interest rate means increasing the value of money in these exchanges.

From the perspective of mainstream economists, the best solution to combat inflation is the use of interest rates to restore the lost value of a country’s national currency. Simply put, when high prices and reduced purchasing power flow through a crisis-ridden economy, the best option to change the playing field is to use the interest rate channel.

Ignoring a Global Experience

Currently, Iran is among the top 10 countries facing the highest inflation rates globally. As mentioned, global powers have also experienced unprecedented inflationary surges since mid-2021, following the recession caused by the COVID-19 pandemic and the onset of the Ukraine war at the beginning of 2022.

It’s important to note that this phenomenon has occurred from superpowers like the U.S. and the UK to the economic environments of countries like Turkey and Russia. In some cases, such as Russia, other factors, including Western sanctions following the military invasion of Ukraine, have significantly impacted inflation. However, the noteworthy point is that almost all these countries have adopted a common approach in the face of unprecedented inflation, which is utilizing the interest rate tool.

However, there is an exception. The Central Bank of Turkey, despite breaking a 23-year inflation record last year, has not ceased suppressing interest rates. This happens while the Turkish government, aiming to create an investment environment, has changed the central bank’s heads to pursue the policy of interest rate suppression.

In fact, it can be said that Turkey is the only country that, despite favorable economic indicators, holds a special place in the club of inflationary economies worldwide. The meaningful connection between increased inflation in this country and the Central Bank of Turkey’s non-use of the interest rate channel is fully evident in the official statistics compared among the mentioned countries.

However, the inflation rate in Turkey has been on a downward trend in 2023, and according to the website Statista, Turkey’s annual inflation rate was recorded at about 55% in February 2023. Interestingly, the approximately 30% retreat in inflation in less than six months in Turkey coincided with a relative increase in the interest rate in this country. This means that although the government has forced the central bank to suppress interest rates in recent years, as soon as the policy shifted, the relative increase in interest rates led to a more than 30% reduction in Turkey’s inflation rate.

Although experts believe that the interest rate in Turkey remains negative and a 55% inflation rate can in no way reflect a country’s economic health, overall, it seems that Turkey’s monetary policymaker has concluded that insisting on interest rate suppression not only does not strengthen investment in this country but also leads the lira into a phase of chronic devaluation, which expands poverty in this country.

What Is the Reason for Interest Rate Suppression in Iran?

As mentioned, the interest rate in Iran also has a significant gap with the inflation rate, and the policymaker does not take action to bridge this deep gap. But what is the reason for this, and why does the Central Bank persist in continuing the policy of interest rate suppression despite having global experiences before it?

To answer this question, attention must be paid to the mechanism of determining the interest rate in Iran. The entity known as the Money and Credit Council is responsible for setting the interest rate. The head of this council is the current governor of the Central Bank of Iran, who must give final approval and announcement of the council’s resolutions.

The problem is that the composition of this council’s members is such that the element of conflict of interest always influences the resolutions of the Money and Credit Council. Members, ranging from government ministers to parliamentary representatives who participate as observers in meetings, each have their specific viewpoints. This defect has turned monetary policymaking from a specialized issue into a governance matter that sees many sensitivities surrounding it.

Thus, it is said that the policymaker cannot consider the interest rate as a monetary tool and take action to decrease or increase it when necessary. This issue once again brings to mind the problem of the Central Bank’s lack of independence in Iran. Independence that manifests in the free use of tools like interest rates by central bank governors.

However, the existing mechanism not only takes this possibility away from the monetary policymaker but has also caused the Central Bank to stray from its primary mission, which is to maintain and protect the national currency’s value. Naturally, when such a situation occurs, controlling inflation will not be the policymaker’s main priority. Therefore, the necessity of using available tools is also overlooked.

Meanwhile, past Central Bank governors have directly or indirectly expressed dissatisfaction with such a mechanism. Even Ali Salehabadi, the former governor of the Central Bank, who faced severe criticism from economists, emphasized the need to increase interest rates in his statements. However, it is clear that his and his predecessors’ motivations did not lead to a constructive outcome against the will of the Money and Credit Council members.

Of course, there are many reasons and factors that have led to over 50 years of inflation dominance in Iran. Naturally, controlling these factors can have reducing effects on the upward trend of inflation, including direct and indirect government borrowing from the Central Bank, distribution of rent, and corruption. However, the point is that conflicts of interest have left the Central Bank with its hands tied and unable to use the most effective tool to control inflation.

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