Monetary genius

by Russ Roberts on September 2, 2008

in Monetary Policy

Usually totalitarian regimes lop off heads, but Iran is considering lopping off zeros (HT: Ewin Barnett):

Iran
is considering lopping three to four zeros off its currency, a top
official said Monday, in an apparent effort to fight out-of-control
inflation that many critics blame on the country’s hardline president.

The governor of the Central Bank of Iran,
Tahmasb Mazaheri, told state-run radio that monetary experts are
studying three options: Cutting three zeros off the rial, cutting four
zeros, or boosting each rial’s value to one-hundredth of a gram of
gold, or about 2,500 rials at current rates.

"We are studying all these three options," Mazaheri said on state-run radio.

The Iranian rial
is now traded at 9,600 rials to one U.S. dollar. That compares with 70
rials against the dollar in 1979, the year an Islamic revolution
toppled the pro-Western Shah Mohammad Reza Pahlavi.

What I like about Mazaheri is his flexibility. Maybe three zeros. Or four. As if the two numbers, three and four, being close together, convey a precision that isn’t quite there.

The AP article continues:

In June, Iran’s government put the inflation rate at a whopping 26
percent. Independent economic experts say the actual inflation rate is
even higher, at more than 30 percent. Prices for vegetables have
tripled and housing prices have doubled since last summer.

The sharp rise in inflation has provoked fierce criticism of hardline President Mahmoud Ahmadinejad
— not only from his reformist opponents, but also from senior
conservatives who helped bring him to power but now accuse him of
mismanaging the economy.

The currency proposals are seen as an effort by the central bank to
reassert control over the country’s monetary supply from Ahmadinejad
and supporters. Critics blame the president for unwisely investing
Iran’s oil windfall and pressuring banks to lower interest rates,
leading to the inflation.

Could be. It happens to the best of countries—politicians like low interest rates, they pressue the head of the Central Bank, and the next thing you know, you have a little inflation on your hands. But 26% a month is a bit more than a little. That kind of achievement usually takes more than just lowering interest rates, though it depends on where they start. The article continues:

But private economists say lopping zeros off the currency won’t
resolve the underlying economic woes, unless the government also adopts
measures to boost production and move toward liberalization and a market economy.

"The solution to contain inflation is economic liberalization, absorbing foreign investment and boosting production," said economist Morteza Allahdad in Tehran.

All good ideas. But if the money supply is growing by leaps and bounds, you want to start there first. Actually, I’d like to know what’s really going on in that Central Bank.

The article then takes an unintentionally comic turn:

The central bank’s vice president, Hossein
Ghazavi, had told several newspapers earlier this week that a special
committee had already been set up to study the proposed currency
reforms. In those interviews, Ghazavi acknowledged a 10,000 rial note
now has the same purchasing power as 25 rials did three decades ago.

Hmmm. A special committee. Committees usually are not the most effective way to get things done. When will the committee finish its report?

Mazaheri set no date for the currency reform but said the study would
take at least a year before the bank could come up with a clear
proposal. Any currency reform plan would need parliament’s approval.

No hurry. Your currency has become monopoly money, but take your time. Take a year or two to think it through.

In recent weeks, Iran has issued higher-denomination notes to try to
ease transactions, which can be complicated and time-consuming with
smaller-denominated bills. The central bank issued 500,000 rial and one
million rial notes that carry the figures 50 and 100 on their backs,
prompting speculation that the rial might lose four zeros.

Yes, that’s a hint. The government will simply announce at some point that from now on, only the B side of the currency is the "real" side. Yessirree, that is really going to help.

Both conservatives and reformists have blamed high inflation on Ahmadinejad’s mismanagement of the economy.

Top conservative cleric Ali Akbar Nateq Nouri, a confidante of Iran’s supreme leader, warned Saturday that Ahmadinejad’s economic policies threaten to keep Iran from its goal of becoming a regional superpower by 2025.

Yes, it will. Nouri is definitely on to something. Hyperinflation is rarely associated with economic progress.

The end of the article makes an attempt to go beyond the interest theory of monetary expansion:

The high inflation is blamed mostly on a huge increase in liquidity,
caused by oil revenues’ impact and Ahmadinejad’s insistence on lowering
bank interest rates, say independent economists. The central bank privately opposed his efforts to lower rates.

Iran earned around $80 billion from crude oil exports last year. Ahmadinejad’s government converted most of that into Iranian rials and injected it into the country as loans, often to political favorites, some critics say.

Many economists had warned that such policies would lead to inflation,
but they view fixes such as removing zeros as little help.

Mohammad Tabibian, an Iranian economist, said bringing discipline to monetary policies is the only true solution.

The troubled African nation of Zimbabwe drew attention to its chaotic economy this summer when it slashed 10 zeros from its currency. Private financial institutions say Zimbabwe’s inflation rate was an astonishing 12.5 million percent in May and estimate it has climbed higher since.

Although Iran is less troubled, many people there, like in
Zimabwe, have attempted to hedge by putting money into outside accounts
in dollars or euros.

I bet they have.

CORRECTION: The inflation rate of 26% is an annual rate. When the article I’m discussing above said "In June" and "whopping" I assumed it was a monthly rate. But according to this article, that is in the ballpark for the annual rate, at least the measured one. At 26%, the average price level doubles (thanks rekniht) every three years, so that if you do sustain that for a while, you do get some very high nominal prices pretty quickly. Thanks to CuriousReader for pointing out the ambiguity.

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{ 9 comments }

kurt September 2, 2008 at 4:11 pm

I would laugh if it were just not so saddening for all those Iranians who have to live under these hypocritical rulers.

CuriousReader September 2, 2008 at 4:40 pm

You mention 26% per MONTH, but the article doesn't seem to say that. Your direct quote just says 26%, which usually means per annum. Which is correct?? Clearly 26% per month (1500% per annum) would be eye-popping.

Frederick Davies September 2, 2008 at 5:09 pm

Oil prices sky high, oil producers reaping it in, and these idiots cannot even manage a modest-sized economy; not even the Russians are that incompetent!

Tom September 2, 2008 at 5:49 pm

If my math doesn't fail me, that means the rial has lost 18.5% of its value versus the dollar every year since 1979. God is great!

rekniht September 2, 2008 at 6:01 pm

Another nitpick:

At a 26% inflation rate the average price level _doubles_ every three years, not triples.

Mr. Econotarian September 2, 2008 at 6:17 pm

How exactly can one "pressure banks to lower interest rates" when charging interest is against Iranian banking law (due to religious issues)?

Russ Roberts September 2, 2008 at 6:46 pm

rekniht,

Fixed. Thanks.

Unit September 2, 2008 at 9:21 pm

Actually removing zeros might worsen inflation, because people loose sense of the value of money. Or is that just a myth?

SB September 3, 2008 at 12:31 pm

Mismanaging an econonmy is an oxymoron. You can't accurately manage an economy. Perhaps one day voters will get this. One day they might look around and see that nobody has ever accurately managed an economy.

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