Iran’s Inflationary Experience: Demand Pressures, External Shocks, and Supply Constraints

Abstract

AbstractThis paper studies determinants of inflation in Iran. The buildup of international reserves has accelerated during the episode of higher oil price. The associated increase in government spending has limited contribution to capacity building and pronounced inflationary pressures, which accelerated at the beginning of the Iran-Iraq war in 1980, and eased at the end of the war in 1988. Accommodating monetary stance has proven to be an important determinant of inflation, both in the long and in the short-runs. In the long-run, depreciation of the rial increases the cost of intermediate goods, increasing inflationary pressures with limited significant effect on output. In contrast, depreciation could boost competitiveness of non-energy exports, in support of higher demand and output growth in the short-run. For policy implications, priorities going forward should be in place to direct both public and private resources toward relaxing binding capacity constraints, capitalizing on oil resources in Iran and the prospects of the positive implications of lifting sanctions in the context of the recent nuclear agreement between Iran and the G5+1 countries.