Determinants of Inflation in Iran and Policies to Curb It

DeterminantsofInflationinIranandPoliciestoCurbIt H.ElifTureandAliRezaKhazaei WP/22/181 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate. TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. 2022 SEP ©2022InternationalMonetaryFundWP/22/181 IMFWorkingPaper MiddleEastandCentralAsiaDepartment DeterminantsofInflationinIranandPoliciestoCurbItPreparedbyH.ElifTureandAliRezaKhazaei* AuthorizedfordistributionbyChristophDuenwald September2022 IMFWorkingPapersdescriberesearchinprogressbytheauthor(s)andarepublishedtoelicitcommentsandtoencouragedebate.TheviewsexpressedinIMFWorkingPapersarethoseoftheauthor(s)anddonotnecessarilyrepresenttheviewsoftheIMF,itsExecutiveBoard,orIMFmanagement. ABSTRACT:HighandvolatileinflationhasbeenanendemiceconomicandsocialissueinIranthathascontributedtorisingpovertyandsocialtensions.Forpolicymakerstoeffectivelyaddresstheinflationproblem,itiscriticaltounderstanditscauses.Thispaperseekstocontributetothisendeavorbyapplyingavectorerror-correctionmodeltostudytheshort-andlong-termdeterminantsofinflationinIranoverthepasttwodecadesandidentifypolicyoptionstocurbit.Usingquarterlydataspanning2004-2021,itfindsthatmoneygrowthdrivesinflationonlyinthelongterm,whilecurrencydepreciation,fiscaldeficits,andsanctions(proxiedbyoilexports)driveinflationbothintheshort-andthelongterm.IntheabsenceofaremovalofUStradeandfinancialsanctionsthatcouldsignificantlyboosttherial,budgetdeficitswillhavetobeadjustedtocontaininflation,albeitgraduallytoavoidhinderingtherecovery.Overthemediumterm,strengtheningtheinflationtargetingframeworkcouldhelpimprovemonetarytransmissionandcontaininflationdurably. RECOMMENDEDCITATION:Ture,H.ElifandAliRezaKhazaei,2022.“DeterminantsofInflationinIranandPoliciestoCurbIt”.IMFWorkingPaper2022/181 JELClassificationNumbers: E31,E37 Keywords: Inflation;Iran;sanctions Author’sE-MailAddress: HTure@imf.org *ThispaperwasauthoredbyH.ElifTure(IMF)withinputsfromAliRezaKhazaei(IMFsummerinternJune-September2021andShahidBeheshtiUniversity).TheauthorwouldliketothankPhilipBarrett,MohamedBelkhir,RezaBoostani,ChristophDuenwald,MaksymIvanyna,MohamedJaber,AsgharShahmoradi,ZeineZeidane,andparticipantsofthevirtualseminarsconductedintheIMF’sMiddleEastandCentralAsiaDepartmentandtheCentralBankofIran’s(CBI)economicresearchandpolicydepartmentforusefulcommentsandsuggestions. WORKINGPAPERS DeterminantsofInflationinIranandPoliciestoCurbIt PreparedbyH.ElifTureandAliRezaKhazaei1 1H.ElifTure(IMF)andAliRezaKhazaei(IMFsummerinternJune-September2021andShahidBeheshtiUniversity). Contents 1.Introduction3 2.InflationinIran:HistoricalTrends4 3.InflationinIran:ModelEstimates8 4.InflationinIran:AlternativeScenarios11 5.PolicyImplications15 Appendix18 References32 FIGURES 1.InflationinIranandItsPeers3 2.ComponentsofInflationinIran5 3.DomesticDriversofInflationinIran6 4.ExternalDriversofInflationinIran7 5.Globaloilvsfoodprices,2004/5-21/228 6.ImpulseResponsesandVarianceDecompositions:Model(1)11 7.ForecastPerformanceofModel(1):ActualvsPredictedInflation12 8.Baseline(Unconditional)Forecastsfor2021Q2-2024Q1UsingModel(1)13 9.ConditionalForecastsfor2021Q2-2024Q1UsingModel(1)14 TABLES 1.NormalizedCointegrating(Long-term)Coefficients9 1.Introduction HighandvolatileinflationhasbeenanendemiceconomicandsocialissueinIranthathascontributedtorisingpovertyandsocialtensions.Iran’sCPIinflationhasfluctuatedsharplyoverthepasttwodecadesarounditsannualaverageof20percent(Figure1.a.),andhasbeenmuchhigherthanthatofIran’semergingmarketandregionalpeers(Figure1.b.).WiththeCOVID-19pandemichittingIran’seconomyontopofpreexistingU.S.tradeandfinancialsanctionsandexacerbatingthesupplyconstraints,annualCPIinflationreachednearly50percentattheendofFY2020/21(Iranianyear1399thatendedonMarch20,2021)andaveraged40percentduringFY2021/22(Iranianyear1400).Coupledwithloweconomicgrowthandhighunemployment,risinginflationhasfueledwidespreadprotestsinthecountryamidasignificanterosioninpurchasingpower.1ThenewgovernmentthattookofficeinAugust2021identifiedtacklinginflationasakeyeconomicpriority.2 Figure1.InflationinIranandItsPeers a.CPIinflationinIran,2001/2-21/22 (percenty-o-y) b.CPIinflationinpeers,2001-21 (percent) Source:CentralBankofIran,StatisticalCenterofIran,andIMFWorldEconomicOutlookDatabase,April2022.MENA:MiddleEastandNorthAfrica;OilExporters:Algeria,Bahrain,Iraq,Kuwait,Libya,Oman,Qatar,SaudiArabia,UnitedArabEmirates,Yemen;OilImporters:Egypt,Jordan,Lebanon,Morocco,WestBankandGaza,Tunisia. Forpolicymakerstoeffectivelyaddresstheinflationproblem,itiscriticaltounderstanditscauses.ThispaperstudiesthedeterminantsofinflationinIrantoidentifyeffectivepoliciestofightit.UsingaVectorErrorCorrectionModel(VECM),thepaperquantifiestheshort-andlong-termimpactofvariousdomesticandexternalfactorsoninflationandillustratesalternativeinflationscenariosusingconditionalforecasts.Usingquarterlydatabetween2004Q2(1383Q1)and2021Q1(1399Q4),itfindsthatwhereasbaseandbr