A SIMPLE MACROECONOMETRIC MODEL OF INFLATION: THE CASE OF IRAN

Since 1971, oil-based less developed countries have experienced sharp increases in their oil export earnings due to successive rises in crude oil price, and, at the same time, rapid increases in the general price level. There have been, however, various ways in which oil exports have interacted with the general price level in those economies. An explicit analysis of such interactions is required in order to make a proper assessment of policies to combat inflation in these countries. This study attempts, first, to develop a model of inflation in order to highlight the primary role of oil export earnings in generating the inflationary process in an economy that is primarily dependent on oil export revenues; and second, to question the effectiveness of conventional stabilization policies aiming at controlling this inflationary process. The specific case to be studied is the Iranian economy during the 1959-1977 period. The model to be developed in this study incorporates the relevant structural characteristics of the Iranian economy: (1) growing oil export revenues raises domestic fiscal deficit; (2) public domestic expenditures respond to inflation faster than tax revenues do, which brings about a further increase in domestic budget deficit; (3) financing this deficit by oil export earnings results in monetary expansion; (4) existing time lag between foreign exchange receipts from oil exports and payments for imports brings about accumulation of exchange reserve, and thus, further rise in money supply; and finally, (5) monetary expansion causes inflation. The results obtained from the econometric estimation of the model and its simulation for alternative policy options were as follows: (a) higher oil export earnings level and its accelerated growth rate had been the major cause of inflation and main factor of its accelerated rate respectively, about 89 percent of the annual inflation rate could be attributed to growing oil export revenues; (b) the inflationary process had been self-perpetuating and a dampening one; (c) restricted monetary policies aimed at controlling the inflation pressures had not been effective; and finally, (d) only a policy of steady-state growth of oil exports could attain the twin objective of a reasonable long-run economic growth and a moderate inflation rate.