Back through the looking glass

Gangway, Alice.  The National Bank is coming through

Kazakhstan’s central bank is anything but dull.  In August, it announced that it would target inflation and that it would let the foreign exchange market set the exchange rate for the tenge, which were mutually exclusive goals.  Predictably, the tenge blew up, losing a third of its value overnight.  Exit Kairat Kelimbetov; enter Daniyar Akishev, who kept the ball rolling by canceling the National Bank’s policy meetings until it had a policy to talk about.  He also said that the Bank wouldn’t intervene in the forex market except when it did, which was where Kelimbetov had wound up.  So now the government has stepped in.  It, not the Bank, is declaring monetary policy.  The Bank is to target inflation and to let the market set the exchange rate, which is where we came in.

This time, there’s one slight difference: The marching orders are coming from Astana, not Almaty.  The National Bank, of course, has never been politically independent: Its chair serves at the pleasure of the President.  But four or five years ago, then-chair Grigorii Marchenko seemed on occasion to have a free hand.  Today, there is not even the pretense of political independence.  This is the sort of thing that gives foreign investors heart fibrillations, since they figure that sooner or later the government will use the Bank for short-run political purposes; the temptation is too strong to resist.  Had the Bank a vestige of credibility left, it’s gone now.

Wait, there’s more.  In October, annualized inflation was over 9%, well above the Bank’s target, so it raised the repo interest rate to 16%, from 12%. The idea is that high interest rates will discourage borrowing and spending, taking the pressure off prices.  Meanwhile, the government is cutting back on spending in order to avoid a deficit.

Tough luck

These tough policies are appropriate if inflation really is the problem.  And yes, inflation in Kazakhstan has been high for years.  Kazakhstanis have come to expect rising prices; so they take steps to protect themselves, such as pressing their bosses for cost-of-living pay hikes, that bring about the very inflation that they feared.

But at the moment, Kazakhstan has another problem – an economic slowdown.  The estimated rate of increase in economic activity (adjusting for prices) in 2015 is below 2%, roughly half of last year’s growth rate.  In Kazakhstan, slowdowns almost always occur because of a fall in demand.  The natural solution is for the Bank to lower interest rates and for the government to spend more than usual, even if it has to borrow.  These steps would increase spending.  But in reality, the Bank and the legislature are doing the opposite.  Whatever the implication for inflation, their tough policies may make the slowdown worse.

The future is not clear.  If oil prices rise next year, they may generate export revenues that will revive the economy.  In that case, today’s tough policies may be just what the doctor ordered for chronic inflation.  But if oil prices languish, the tough policies may cost Kazakhstanis their jobs. – Leon Taylor tayloralmaty@gmail.com

Notes

The market approach to the exchange rate and inflation targeting were mutually exclusive policies because the tenge was overvalued with respect to the dollar.  The market would devalue the tenge, raising tenge prices of imports.  This in turn would enable domestic producers competing with importers to raise their own prices.

How do we know that demand shifts generate most business cycles in Kazakhstan?  Because the correlation between the price level (which is the country’s average price) and output is positive and strong.  From 2000 through 2011, the simple correlation was above .97, according to quarterly data from the National Bank.  This pattern characterizes a demand shift.  For example, when demand falls, sellers will lower prices to try to work off their inventories.  Output and prices will decline at the same time.