Geopolitical Shocks and Monetary Discipline: Achilles' Heel of Inflation Control in the Currency Market

Although the monetary policymaker prevented regional shocks from spilling over into hyperinflation by containing a 51% liquidity gap, sustaining stability requires active oversight of the currency market.

According to Mehr reporter, the analysis of the fundamental trends of Iran's economy in recent months shows that the country's economy is at the intersection of two opposing forces; On the one hand, the continuation of contractionary policies and bank balance sheet management, which has limited the speed of circulation and growth of monetary quantities, and on the other hand, the intensification of uncertainties caused by geopolitical developments and regional conflicts, which has kept the engine of inflationary expectations active. In a situation where a gap of 51% has formed between liquidity growth and inflation rate, economic observers are facing a serious question about why the prices do not converge with the relaxed monetary indicators.

Economic officials and the country's management team assess the root of these jumps and unrest in the consumer price index not in the disruption of the internal structure of the money creation system, but in the consequences of war, external threats and the emotional atmosphere caused by political fluctuations in the region; A space that has moved the nominal variables away from their historical balance by changing the behavior of economic activists.

The stability of the monetary barrier against the fire of regional tensions

The experience of emerging economies in facing wars and security threats indicates that geopolitical shocks have the potential to quickly turn into destructive phenomena such as hyperinflation. When the fire of regional conflicts flares up, the speed of money circulation accelerates due to the general fear of falling asset values, and liquidity preference drops to its lowest level.

In such a situation, if the central bank loses monetary discipline and compromises with large deficits caused by emergency conditions, the chain of destruction of the value of the national currency will gain exponential momentum. However, the statistical evidence shows that by adhering to the stabilization frameworks, Iran's monetary policy has been able to prevent the blocking of banking resources and the blind overflow of powerful resources to the consumer markets and to establish an effective line of defense against the shock waves of war.

Mehrdad Kashanizadeh, an expert on macroeconomic issues, said in this regard: What happened in the past months was a rare event in the history of the country's monetary policy; Because it is usually impossible to control the growth of liquidity in a quasi-war environment and security risks. But the statistics show that liquidity growth was curbed by the policy of controlling some of the banks' balance sheets in predetermined channels.

In other words, if the monetary policymaker did not pull this emergency brake, the collision of exogenous shocks with the abandoned liquidity would undoubtedly lead the country to the abyss of an uncontrollable hyperinflation. However, blocking this channel alone could not prevent prices from flying; Because part of the behavior of the markets is not controlled by the money balance, but by the perception of the activists towards the future, and this has created the mystery of the gap between liquidity and inflation.

Traces of uncertainty in the corridor of inflationary expectations

When exogenous uncertainties peak, the signaling efficiency of traditional monetary variables is impaired. Market participants, consumers and capital owners adjust their behavior not based on the growth rate of the money supply, but based on the most pessimistic geopolitical scenarios. Buying safe assets, withdrawing capital from term deposits and taking refuge in the commodity and gold markets will cause price indices to jump before money has been printed to support them.

Based on this fact, the officials of the economic sector argue that most of the existing inflation is a phenomenon imposed by the geopolitical environment and oppressive sanctions. This analysis from the point of view of short-term causality is completely consistent with the field realities, because the cost of risk coverage in all production sectors and the domestic supply chain has increased greatly and goods are priced with higher precautionary coefficients.

However, reducing all problems to regional pressures and military shocks cannot be a comprehensive policy strategy. Economists warn that negative expectations will stabilize at higher levels if war-related uncertainties are treated as a permanent factor and domestic mechanisms are not rearranged to withstand them. Geopolitical shocks increase the speed of conversion of non-current deposits into cash and pseudo-money by directly affecting speculative demand. As a result, even with the stability of the quantity of liquidity, the intensity of the circulation of capital flows in parallel markets increases and imposes its inflationary effect on people's livelihood items; A process whose focal point has always been the fluctuations of the currency market.

The Achilles heel of inflation control in the currency market

Although the monetary roots of inflation are restrained in the regulatory corridors and its expected roots are linked to the turmoil in the region, the real support point of all these developments is the behavior of foreign bills and currency remittances. In Iran's economic structure, the exchange rate is not only a variable in foreign trade, but also the nominal anchor of the expectations of all members of the society.

When the exchange rate fluctuates, the price of the smallest goods without import dependence also changes. In the meantime, although some of the currency fluctuations are caused by the psychological atmosphere of war and security threats, experts believe that the central bank has a duty to take over the command of this market with much greater seriousness and not allow psychological inflammation to turn into unbridled price jumps in the exchange board and unofficial channels.

Gholamreza Akhwan, an expert in the field of finance and property markets, continued this analysis and told Mehr reporter: You cannot blame all the pressures on regional developments and neglect the responsibility of the monetary supervisory body. The undeniable fact is that the main factor in the expansion of inflationary waves in the current situation is the lack of consistent, intelligent and decisive supervision in controlling the exchange rate. Our currency market suffers from the lack of systematic monitoring of the bottlenecks of the Rial circulation and credit allocations.

The central bank is obliged to block suspicious transactions by using regulatory tools and monitor the return of foreign currency from the export of petrochemicals, steels and minerals. When speculators and informal actors can manipulate the price of the leader of the entire market with small volumes, it is an indication that the field and structural supervision has not been deterrent enough. This is a fundamental issue and without strict discipline in this sector, previous efforts to control money creation will not bear fruit.

He added: In times of geopolitical crises, currency monitoring should change from a daily administrative situation to an emergency management situation. Allowing the unruly activity of brokerage networks and letting money circulate in intermediary accounts sends a signal of policymaker incompetence to society, the immediate result of which is a rush to the markets for capital conversion. Therefore, the central bank must accept the fact that the task of stabilization is not only limited to closing the balance sheets of banks, but the careful control of the sources of currency entry and exit, the intelligent management of the allocation of preferential and commercial currencies and preventing the leakage of government resources to the free market are the backbone of curbing inflation at the current time.

The return path of the variables to the long-term equilibrium circuit

In order to get out of the current situation and return macro variables to historical and long-term averages, Iran's economy needs a balanced road map that covers monetary, financial and currency dimensions at the same time. In the first place, the monetary policy maker should strengthen his defensive barrier against overdrafts and the government's financial domination to ensure that budgetary indiscipline is not imposed on the central bank under the pretext of specific regional conditions. Stability in this sector will guarantee that the fundamental variables do not deviate from the targeted path.

In the next step, the main focus should be on closing currency gaps and establishing peace in the exchange market. The return of the variables to the equilibrium circuit will be possible only when the economic activists witness the authority and undisputed supervision of the Central Bank over all foreign exchange resources and expenses of the country. Clarifying the process of supply and demand, eliminating rents caused by multi-rates, accelerating the clearance of basic goods and intercepting large-scale rials active in speculative markets will strengthen the regulatory foundations. By combining these measures with diplomatic approaches to reduce regional tensions, the country's economy will have the capacity to overcome geopolitical uncertainties and, while curbing inflationary expectations, provide the context for the return of peace and predictability to the production and trade environment.