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Thursday, July 17, 2008
A Riddle of Liquidity and Interest Rate
A RIDDLE OF LIQUIDITY AND INTEREST RATE
Mahatta/Alchemist
Mahatta/Alchemist
Empirically-constructed curves of demand of and supply for moneyto explain how a money-siphoned mechanism works
The article is divided into two parts. The first Part illustrates a certain money market mechanism through which additional supply of money is schematically siphoned out in order to salvage the sinking financial institutions via the lendings of Financial Institutions Development Fund about three years ago. It has dried up a liquidity available for the real sector with an embedment of higher interest rate. A certain part of this article is to show that there remains a room in case of no additional fund received that an interest rate could be brought down without affecting the FIDF operation, and also benevolent to the real sector. The latter Part is concerned about the about-face situation where interest rates have been brought down continually for the sake of capital re-structuring of the financial institutions, while leaving the real sector at random with lending malfunctions. This Part also suggests a minimum deposit interest rate pegging strategy, a way of compelling the banks to drain their liquidity.
PART I
CHARACTERIZATIONS
With a limited additional source of fund as characterized by SS curve of which the vertical portion is reflecting its scarcity. A curve of FIDF demand for money, DD(FIDF), is something positioned upper and right-hand-side a demand for money curve of the real sector, DD(real sector), and then bent downward as if it is meeting a saturation point along the salient part of inelasticity.
IMPASSIVE SCENARIO
An artificial rate of interest i* enables the FIDF to draw on the additional money supply out of the money market at the intersection A*. Given the fixed additional supply OM*, it is useless to even command a lowering of interest rate by way of shifting a concave portion of such a unique money supply curve straightly downward towards S'S curve or S''S curve. As far as the intersection of DD(FIDF) curve and the money supply curve is struck at A*, prominently kept above those corresponding levels of interest rate; where a DD(real sector) curve could intersect the respective money supply curves S'S and S''S, FIDF could entirely suck it out.
MONEY INJECTION SCENARIO
Try ways and means of injecting an additional amount of money into the market, for example, from OM* to OM2 by shifting a supply curve to S1S1, an intersection remains at full satisfaction of FIDF as long as its demand portion (beyond a range of slope-downward towards a kink) stays above a demand curve of the real sector. Conspicuously, the intersection A1 is above the intersection A1', permitting the FIDF to become at subdued satisfaction by occupying a portion of OM1 at the rate of i1, while the remainder M1M2 (=OM2-OM1)would be taken for granted by the real sector at the corresponding rate of i1'. Again, at the intersection A2', where a demand curve of the real sector DD(real sector) struck a shifted supply curve S2S1, and where a lower portion of DD(real sector) is now a little bit above that of FIDF, it enables the real sector to grasp a whole amount of additional OM2 at the rate of i2'. (Please note further exploration should be made into scenarios on which either condition of either an outward/inward shift of DD(FIDF) curve or DD(real sector) curve or condition of those in combinations is stipulated.)
ARTIFICIAL RATE - TO BE REVISED
Apart from a purview of money levelled-up crucible, it is needless to say that market interest rate would slide down discretely as a result of incremental fund to be induced. The above exhibition may elucidate an ardent debate that, under an FIDF's eccentricity of money-siphon arrangement, none among two monetary parameters is regarded as either a cause or an effect. It commands, within the ambient complexity, an artificial interest rate, as critically determined by the Bank of Thailand, be right away brought down, perhaps step by step, towards a nominal one as long as the demand curve of FIDF and the money supply curve SS are so artificially constructed and confined to its limited source OM* respectively. The real sector will virtually gain nothing from the foregoing but a lower cost of fund where a market borrowing rate of interest would follow. To do this, all overstated cost elements of financing of FIDF should be truncated as financial institutions absorb nothing (e.g. no operating cost incurred, no need to gain a considerable spread) in conducting a viciously-cycled transaction through a repurchase window - that is benevolent to FIDF. Inflation rate which is also regarded as interest rate determinant is likely containable unless the current strict monetary policies ruin most of the national supply potentials. Despite experiencing a chronic liquidity problem on one side, lowering of high interest rate towards a nominal one is at least conducive to business survival chiefly on part of financial cost on the other side!
PART II
PART I
CHARACTERIZATIONS
With a limited additional source of fund as characterized by SS curve of which the vertical portion is reflecting its scarcity. A curve of FIDF demand for money, DD(FIDF), is something positioned upper and right-hand-side a demand for money curve of the real sector, DD(real sector), and then bent downward as if it is meeting a saturation point along the salient part of inelasticity.
IMPASSIVE SCENARIO
An artificial rate of interest i* enables the FIDF to draw on the additional money supply out of the money market at the intersection A*. Given the fixed additional supply OM*, it is useless to even command a lowering of interest rate by way of shifting a concave portion of such a unique money supply curve straightly downward towards S'S curve or S''S curve. As far as the intersection of DD(FIDF) curve and the money supply curve is struck at A*, prominently kept above those corresponding levels of interest rate; where a DD(real sector) curve could intersect the respective money supply curves S'S and S''S, FIDF could entirely suck it out.
MONEY INJECTION SCENARIO
Try ways and means of injecting an additional amount of money into the market, for example, from OM* to OM2 by shifting a supply curve to S1S1, an intersection remains at full satisfaction of FIDF as long as its demand portion (beyond a range of slope-downward towards a kink) stays above a demand curve of the real sector. Conspicuously, the intersection A1 is above the intersection A1', permitting the FIDF to become at subdued satisfaction by occupying a portion of OM1 at the rate of i1, while the remainder M1M2 (=OM2-OM1)would be taken for granted by the real sector at the corresponding rate of i1'. Again, at the intersection A2', where a demand curve of the real sector DD(real sector) struck a shifted supply curve S2S1, and where a lower portion of DD(real sector) is now a little bit above that of FIDF, it enables the real sector to grasp a whole amount of additional OM2 at the rate of i2'. (Please note further exploration should be made into scenarios on which either condition of either an outward/inward shift of DD(FIDF) curve or DD(real sector) curve or condition of those in combinations is stipulated.)
ARTIFICIAL RATE - TO BE REVISED
Apart from a purview of money levelled-up crucible, it is needless to say that market interest rate would slide down discretely as a result of incremental fund to be induced. The above exhibition may elucidate an ardent debate that, under an FIDF's eccentricity of money-siphon arrangement, none among two monetary parameters is regarded as either a cause or an effect. It commands, within the ambient complexity, an artificial interest rate, as critically determined by the Bank of Thailand, be right away brought down, perhaps step by step, towards a nominal one as long as the demand curve of FIDF and the money supply curve SS are so artificially constructed and confined to its limited source OM* respectively. The real sector will virtually gain nothing from the foregoing but a lower cost of fund where a market borrowing rate of interest would follow. To do this, all overstated cost elements of financing of FIDF should be truncated as financial institutions absorb nothing (e.g. no operating cost incurred, no need to gain a considerable spread) in conducting a viciously-cycled transaction through a repurchase window - that is benevolent to FIDF. Inflation rate which is also regarded as interest rate determinant is likely containable unless the current strict monetary policies ruin most of the national supply potentials. Despite experiencing a chronic liquidity problem on one side, lowering of high interest rate towards a nominal one is at least conducive to business survival chiefly on part of financial cost on the other side!
PART II
ABOUT-FACE SITUATIONS
The foregoing scenario was pertinent to the past three years that the previous administration had induldged in maintenance of high rates for a long time before untimely letting it loose (leaving a number of bankruptcies behind) with a view to surviving the financial institutions on capital upheaval side. Both deposit and lending rates have been manipulated (not driven by market mechanism as often cited) on a diving track (with a wide spread) for making up for dwindling earnings from crippled lendings.
It is remarkable that if the present administration let it be like the past administration (as well as the naive monetary policies on stubborn low interest rate and timid inflation-targetting of the Bank of Thailand), the end result would be either one would go earlier between financial sector and public (including a real sector) sector!
HOW TO HANDLE
A problem-solving is most likely to put more weight on boosting a purchasing power (on the earnings side) than a debt settlement side. In other words, the administration should strengthen and focus on the earning hand not the debt-settling hand. No repayment can be made unless having money. On a broad amount of five trillion baht national savings, every cut of one per cent of deposit is equivalent to a yearly loss of fifty thoundsands million baht purchasing power. Notwithstanding how low an interest rate would be, interest-stimulated investment policy stays impassive in a liquidity-cum-debt trap situation as no interest resilience can yield on investment.
It is requisite that the administration peg the floor (minimum) for deposit rate at which the banks would suffer a loss unless injecting money into the economy through their lending hands, a way of turning around the economy. By this, a proportion of contributions to the economy is believed to account for much larger than that of a set-back of the recurrence of non-performing loans with which a national assets management corporation could appreciably cope. A three-year attest of business strength of the survived business firms is likely sufficient for the banks to restore their functional lendings as usual. An afraid of facing NPL recurrence should not be an excuse any longer.
Chumphol Mahattanakul
The foregoing scenario was pertinent to the past three years that the previous administration had induldged in maintenance of high rates for a long time before untimely letting it loose (leaving a number of bankruptcies behind) with a view to surviving the financial institutions on capital upheaval side. Both deposit and lending rates have been manipulated (not driven by market mechanism as often cited) on a diving track (with a wide spread) for making up for dwindling earnings from crippled lendings.
It is remarkable that if the present administration let it be like the past administration (as well as the naive monetary policies on stubborn low interest rate and timid inflation-targetting of the Bank of Thailand), the end result would be either one would go earlier between financial sector and public (including a real sector) sector!
HOW TO HANDLE
A problem-solving is most likely to put more weight on boosting a purchasing power (on the earnings side) than a debt settlement side. In other words, the administration should strengthen and focus on the earning hand not the debt-settling hand. No repayment can be made unless having money. On a broad amount of five trillion baht national savings, every cut of one per cent of deposit is equivalent to a yearly loss of fifty thoundsands million baht purchasing power. Notwithstanding how low an interest rate would be, interest-stimulated investment policy stays impassive in a liquidity-cum-debt trap situation as no interest resilience can yield on investment.
It is requisite that the administration peg the floor (minimum) for deposit rate at which the banks would suffer a loss unless injecting money into the economy through their lending hands, a way of turning around the economy. By this, a proportion of contributions to the economy is believed to account for much larger than that of a set-back of the recurrence of non-performing loans with which a national assets management corporation could appreciably cope. A three-year attest of business strength of the survived business firms is likely sufficient for the banks to restore their functional lendings as usual. An afraid of facing NPL recurrence should not be an excuse any longer.
Chumphol Mahattanakul
B.Econ. (Quantitative), B.Eng. (Electrical), M.S. (Operations Research)
May 13, 1998
Bangkok
Bangkok
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