Rearranging priorities in the monetary policy of the Central Bank of Iraq

      Comments Off on Rearranging priorities in the monetary policy of the Central Bank of Iraq
Test

 

 

Author: Dr. Lecturer Firas Hussein Ali/ head of the Crisis management Department

Translated by: Hiba Abbas Mohammed Ali

Reviewed by: Lecturer. Hussain B Abdulameer

 

 

The monetary policy is the main tool for the central bank intervention in the economic activity of any country, weather developed or developing country, in order to achieve certain objectives, one of them is price stability, increase growth rates in the economy, increase use of available resources, treatment of balance of payments imbalances, contributing to reducing unemployment. Monetary policy reforms are linked to all policies that will contribute to increasing monetary policy capacity levels in achieving their key objectives. Many current studies agree that monetary policy should be primarily concerned with providing an environment conducive to long-term economic growth by providing price stability that increases confidence levels among economic actors and supports consumption and investment levels.

 

In this context, many studies confirm the existence of a disciplined and inverse relation between inflation rate and long-term growth, as high inflation adversely affects economic growth, leads to increased levels of uncertainty and weakens purchasing power levels and thus negatively affects consumption and savings, especially after the inflation rate exceeded specific levels. High volatility in inflation also weakens price mechanisms and reduces productivity and economic growth. On the other hand, other studies have concluded that there is an acceptable level of inflation to drive economic growth and hence a positive relationship between the two variables, especially in developed economies. The rise in prices leads to a decline in real wages for workers, which motivates producers to employ more workers and increase production.[i]

 

Mechanism of the impact of monetary policy on economic activity

The impact of monetary policy can be transferred to economic activity through the channels of monetary policy through which the impact of monetary policy transfer to the final target, and the mechanism of transmission of the impact of monetary policy is strongly influenced by the following variables:

 

  • The flexibility of economic variables.
  • The flexibility of variables within the structure of the financial system in the country.
  • Macroeconomic
  • Economic conditions in general

 

Many of economists tend to distinguish between what is known as:

 

  • Transition of the monetary policy impact from the monetary perspective, thus from this perspective, monetary policy affects the demand side of financial resources (demand for credit) through changes in the interest rate.
  • Transmission of monetary policy impact from a Credit Perspective, thus from this perspective, the transmission of the monetary policy impact is done by influencing the supply of financial resources (Credit offer). The money perspective is built on the interest rate channel but the credit perspective emphasizes the role of financial intermediation or banks in the impact of monetary policy on economic activity, where banks play an important role as the largest financial intermediation institutions in the economy.

 

 

Channels of the impact of monetary policy transmission to economic activity

 

First: the traditional channel of interest rates (monetary perspective) is a traditional channel for the monetary policy transition to the growth target, the traditional policy is working on push up nominal interest rates, which is working on the rise of it’s real price and higher the cost of capital, which leads to a reduction in demand for investment and then decline in total demand including the growth.

 

Second: The exchange rate channel, this channel is used on one hand to influence on exports and on the other hand, is used in addition to interest rates in attracting foreign investment.

 

Third: James Tobin theory explains how monetary policy affects the economy through its impact on stock valuation.

 

As the monetary policy affects the prices of securities through the decline in money supply, which leads to the reduction of interest or the deficit of cash balances in the family sector, which leads to the direction of units of the family sector to the stock market to sell their securities or not to buy securities, which means the decline in the demand for securities and the direction of the prices of these securities to decline and lead to the decline in share prices and then the decline in market value and then the decline of investment and then income.[ii]

 

Monetary Policy of the Central Bank of Iraq

During the previous period, the Central Bank of Iraq, followed used to adopt the policy of  holding the stick from the middle to achieve a balance between two contradictions the first the economy of the state and its relationship to this large rent economy and the other is keeping up the free market, It is a pale market that serving the internal marketing activity and the movement of money abroad regardless of the desired results in the [ building of an economic model generates the movement of inflows and outflows in foreign currency away from this bilateral or polarization between two different economies (State and market) and flows (foreign currency inflows provided by the state economy and outflows from that currency, which the private sector tends to one direction beyond the border without looking back). And used a policy of intervention in the exchange market to reach a stable level in the Iraqi dinar exchange rate in a successful attempt to test its tools to address inflationary expectations starting from the concept that modern monetary policies are the policies that determine the art of managing expectations.[iii]

 

The monetary policy in Iraq faces a number of other challenges and pressures, the most important is the (deficit in net non-oil revenues, state budget deficit, balance of payments deficit other than oil, external factors weakening the role of traditional monetary policy instruments in controlling the money supply.

 

Knowing the nature of the state’s expenditure and its revenues, and what the local currency represents in contrast with the local revenues, is the important input to the structure and characteristics of the economy and public finance of the state. The general phenomenon that dominates the structure of the economy and public finance is that the state depends on covering its expenses on the dollars that derived from the export of oil by more than 90%, indicating a structural imbalance that does not achieve financial stability and financial sustainability, and indicates the inability of fiscal policy to create a necessary balance between the state revenue in local currency and its expenses in local currency, it also points to the large absence of real economic sectors and the diversification of their production.[iv]

 

 

Weakness of the role of traditional monetary policy instruments in controlling money supply

Monetary policy that usually uses its traditional tools to control the money supply, like:-

  • Open market operations (buying and selling bonds, weekly and monthly deposits)
  • Discount rate against re-deduction of commercial paper and treasury bills
  • interest rate

 

The absence of an effective financial market, low financial depth (capital ratio of companies contributing to GDP) does not exceed 2%, the phenomenon of the monetary economy, the tendency to economize rather than saving, and the lack of public awareness. This environment weakens the role of monetary policy instruments in performing its tasks and to achieve its purposes in controlling the supply of money or directing it to serve economic objectives.

 

So, the sale of the currency (selling the dollar against the dinar) plays a key role in:-

  • Sterilization of surplus cash (to prevent inflation), which is derived from the state budget expenditures.
  • Maintain the stability of the exchange rate, as the central bank the monopolist of natural foreign currency (The oil dollar).
  • Financing foreign trade, investors’ transfers and other purposes

 

On this basis, the national market enjoyed stable exchange rates and stability in the general level of prices and the fall of inflation to the tenth rank after the high levels that it reached previously, as well as the rise of the reserves of the Central Bank of foreign exchange to the two decimal places in dollar value, the highest in the history of the country, but the Central Bank has not been able to resolve the contradiction between the market economy and its aspirations and  profitability towards the aspiration of the state economy and its individuality in the search for social profit and lacks the economic vision of the movement of the economic system in Iraq. Thus a complex and lost equation has made the national economy and the search for its solutions as an economic ship without a captain. The rise or fall of the Iraqi dinar is not the product of weakness or strength in the financial sector of the state (public finance and the central bank), but it is the product of those who resolve the conflict and hold the helm of the master. A trend in the waters of the Iraqi economy rushing towards its estuaries beyond the borders.[v]

 

 

 

 

Conclusion

 

The Central Bank needs to think seriously to achieve other objectives other than stability in the exchange rate or targeting inflation, but it has to think of the next two goals comprehensive use and balance of payments, which are one of the most important goals of the Central Bank in the past. An acceptable rate of inflation would certainly contribute to increased economic growth and thus lower real wages for labor, which would encourage producers to employ more workers and increase production. In addition, the reduction of the real and nominal interest rate will stimulate investment, especially in the short term. The instruments owned by the Central Bank are capable of influencing economic activity through a variety of channels. While not ignoring the goal of price stability being one of the priorities of the Central Bank of Iraq.

 

 

References:

 

[i]– محمد اسماعيل وهبة عبد المنعم، دور الإصلاحات الاقتصادية في دعم النمو في الدول العربية، صندوق النقد العربي، الامارات العربية المتحدة ، فبراير، 2018، ص17.

[ii] – سامي خليل ، النظريات والسياسات النقدية والمالية، الجزء الاول ، شركة كاظمة للنشر والترجمة والتوزيع، الكويت ،1982، ص 172-ص182.

[iii] – مظهر محمد صالح، المعادلة الضائعة في الاقتصاد العراقي : من يحسم التناقض بين اقتصاد الدولة وهيمنة السوق الحر، بحث منشور على الموقع الرسمي للبنك المركزي العراقي.

[iv] – علي محسن اسماعيل، السياسة النقدية التحديات وسبل مواجهتها، بحث منشور على الموقع الرسمي للبنك المركزي العراقي،2017.

[v] – مظهر محمد صالح، المعادلة الضائعة في الاقتصاد العراقي : من يحسم التناقض بين اقتصاد الدولة وهيمنة السوق الحر، مصدر سابق.