The National Sphinx of Kazakhstan

Why is the central bank cutting interest rates?

To read the news, you would think that Kazakhstan’s central bank must look like the Sphinx. On January 15, the National Bank cut the base interest rate -- which affects rates throughout the economy -- from 10.25% to 9.75%. The Conway Bulletin said this was partly due to the fact that “the economy is on the mend.” Pause here for head-scratching: Usually central banks cut interest rates because the economy is not on the mend. Lower interest rates spur borrowing and spending; firms respond by producing more. An interest rate cut is the prescription for an anemic economy, not a healthy one.

In reality, the Bank attributed its rate cut partly to “the continuing weak recovery of the domestic demand.” The operative word in that phrase is “weak.” The Bank wants to boost demand, so it is cutting rates.

This Keynesian policy is a little questionable. The government’s statistical committee puts the annual rate of economic growth at 5.2%, which is not exactly anemic. Note that the base interest rate affects all demand for Kazakhstani products, not just the demand of Kazakhstanis. A rate cut can weaken the tenge, making the country’s products cheaper for foreigners to buy (by lowering their dollar prices) and thus boosting demand for its exports. In short, the rate cut might push production towards full capacity -- boosting prices rather than output, since the economy is already producing as much as it comfortably can.

So the key question is whether the economy is so close to full capacity that a stimulus to demand could tip it over the cliff. One approach is to see whether the unemployment rate – the share of the labor force that is looking for work but cannot find it – is unusually low.  The answer is not clear. Last December, the unemployment rate was 5% -- a bit below the average December rate in years since 2010, when the economy began to recover from the financial crisis (5.2%).     

The Conway Bulletin goes on to say that the Bank recognized “some downside risks to its forecast,” like “external factors such as oil prices sliding once again.” What the Bank actually said was this: “Continuation of the OPEC+ agreement about the oil production cuts while keeping the current quota in November 2017 reduces the risks of the significant oil price drop.” Granted, the Bank’s command of English is rather funky, but its point is that oil prices have become less likely to fall.

And now, the news…

In addition to misstating the Bank’s stance, the media are missing the real news. At the end of its news release, the Bank suggests that it is targeting the real rate of interest. This is the normal interest rate (I mean the rate that banks quote for loans) minus the expected rate of increase in prices (inflation). To the real interest rate, lenders tack on the expected rate of inflation because they anticipate getting paid back after prices have risen, which would reduce the purchasing power of their dough. If lenders think that prices will rise 10% next year, they will raise their normal interest rates by 10% to compensate. The Bank said that it was cutting the base interest rate because inflation rates were likely to fall.  Since the real interest rate is the normal rate minus the rate of expected inflation, it appears that the Bank is stabilizing the real rate.  

For example, suppose that the normal rate is 10% and the expected rate of inflation is 8%.  Then the real interest rate is 10% - 8% = 2%.  Now suppose that expected inflation falls to 7%.  The real interest rate would rise to 3% (10% - 7%). If the Bank is targeting the real interest rate, then it would lower the base rate to 9% (since 9% - 7% = 2%). This seems to be what the Bank has in mind.

But as the Bank governor, Daniyar Akishev, recently told a Russian-language newspaper, Delovoy Kazakhstan, the Bank’s priority is to reduce the rate of inflation. This is not consistent with targeting the real interest rate. For example, a rise in demand for Kazakhstani products will push up the real interest rate by boosting demand for tenge and loans. If the Bank is targeting the real interest rate, it will have to print money in order to lower it. (Abstruse digression: The real interest rate is the price of holding tenge, since you must forego interest payments if you put your money in the mattress rather than in securities. As with any other product, an increase in the supply of tenge will lower its price.) The new money could easily overheat the economy, raising the unexpected rate of inflation. So, what does the National Bank really want to do? Dampen inflation, or hold steady the real interest rate? – Leon Taylor tayloralmaty@gmail.com

References

The Conway Bulletin. Kazakhstan cuts interests, says economy is improving.  January 21, 2018. Online.

Алевтина Донских.  Данияр Акишев: «Регулятору важно всегда быть бдительным». Деловой Казахстан. December 21, 2017.

National Bank of Kazakhstan. Press-release No. 1: The base rate reduced to 9.75%. January 15, 2018. www.nationalbank.kz