Does a change in the bank interest rate lead to a decrease in liquidity?
According to Iran Economist, the interest rate is one of the key variables in the economy that can have significant effects on other macroeconomic variables, including inflation and liquidity; One of the main platforms for the implementation of monetary policy by central banks to control inflation is the change in the interest rate of the interbank market and, accordingly, the deposit interest rate and the facility interest rate.
Based on the experience of other countries, some economic experts believe that one of the solutions to reduce inflation in the advanced economies of the world is to use the interest rate tool, in other words, increasing the interest rate can lead to a decrease in liquidity growth and, as a result, a decrease in the inflation rate.
However, in contrast to another group of economic experts, based on the structural differences between Iran’s economy and other countries, they do not consider the interest rate option to be a powerful and accurate tool to reduce liquidity growth and inflation; Rather, from their point of view, based on the experience of liquidity growth in the country in the past years, there is not much relationship between liquidity growth and interest rate.
* Notification of new deposit interest rates; Changes that did not convince anyone
Despite the strong disagreement among economic experts regarding the function of increasing the interest rate as a monetary policy in the current conditions of the Iranian economy, finally, in the middle of February of last year, in a circular, the Central Bank approved the resolution of the Money and Credit Council regarding the modification of the deposit interest rate and bank facilities. Notified the banking network.
According to this circular, the interest rate of bank facilities became 23% and the interest rate of 3-year bank deposits became 22.5%; Previously, and according to the previous resolution of the Money and Credit Council, the interest rate of bank deposits was 18%, which, of course, reached 20% with the tacit agreement of the Central Bank and the banks recently and before the new decision was taken.
Adoption of this decision by the Money and Credit Council, of course, did not convince both groups of supporters and opponents of the interest rate increase, so that the opponents basically follow this path to curb inflation and liquidity, referring to the experiences of some countries such as Argentina and Zimbabwe. 200% interest rate and 240% inflation record in 2022) were wrong, on the other hand, the supporters also pointed to the concept of real deposit interest rate (nominal interest minus inflation), although the increase of interest rate is based on the existing inflationary expectations in the society. They evaluate it as positive, but they consider this amount of increase to be insufficient considering the 40-50% inflation.
* Can an increase in the interest rate lead to a decrease in liquidity?
At first glance, since banks are obliged to pay more interest for their customers’ deposits by increasing the deposit interest rate, it may be thought that this policy will definitely lead to an increase in liquidity, but there is another side to this issue. which is mentioned below.
Some economic experts believe that the interest rate of the facility should be set at levels much lower than the high rates of inflation in the current period and the expected inflation in the future period, considering the negativity of the real interest rate of the facility (after deducting the inflation rate from the nominal interest rate) and the expected yield. Above other financial and property instruments, especially in the conditions of intensifying speculative and speculative behavior in some markets, it creates a very high demand for receiving bank facilities (beyond the ability of the banking system to provide facilities).
The increase in the demand for facilities can also be a strong driving engine for the creation of bank money and cause a higher growth of liquidity and intensification of inflationary pressures, therefore, the use of the interest rate tool, although from the channel of interest increase belonging to deposits, may increase the amount of liquidity, but this action simultaneously From the channel of reducing the demand for facilities, it leads to a decrease in liquidity.
* Changing the interest rate alone cannot reduce liquidity
In this regard, Ali Sarzaim, professor of economics at Allameh Tabatabai University, said in an interview with Iran Economist about the relationship between bank interest rates and the country’s liquidity: contractionary monetary policies cannot be accompanied by low bank interest rates; That is, when the country’s monetary policy is contractionary, the bank interest rate will definitely be higher.
He added: With the increase in the interest rate, the amount of bank loans will decrease, and this will reduce the amount of money in the economy. Because of this, the price of the interest rate increases.
* 4 basic solutions to reduce the inflation rate
Sarzaim stated that several things must be done in tandem to reduce inflation and said: liquidity control should be done along with the increase in bank interest rates (only in relation to deposits, not loan interest) to reduce the demand for loans in the economy, and at the same time from a political point of view In order to create a positive outlook for the country, on the other hand, the currency market must also stabilize; Together, these items will be effective in controlling inflation.
* Banks should reduce the payment of credit facilities
Regarding the financial discipline of banks, this economic expert said: it is necessary that most of the loans go to the production sector, currently there is a strong pressure to receive loans, that’s why new loans do not reach the production sector; Therefore, banks should reduce overdraft facilities.
According to him, the increase in the exchange rate has also increased the demand for working capital; That is, due to the fact that the price of the dollar has increased, importers need twice as much working capital to carry out the same amount of imports as before.
Sarzaim stated: Changing the interest rate alone cannot change the country’s liquidity, and in other words, all the mentioned items are effective in reducing or increasing liquidity.
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