Dynamic path through of oil price shocks into inflation in Iran: application of Markov switching and TVP-VAR models

Abstract

Purpose The main purpose of this paper is to investigate the dynamic effects of the oil price shocks on Iran’s inflation in the period 1993:2–2018:2 Design/methodology/approach The main purpose of this paper is to investigate the dynamic effects of the oil price shocks on Iran’s inflation in the period 1993:2–2018:2 using the time-varying parameter vector autoregressive (TVP-VAR) model. The dynamics of the results enable us to study the amount and severity of the impact of the oil price shocks on inflation with the distinction of the sanctioned and non-sanctioned periods. The volume of oil export is used to identify the effective oil sanctions. The period is divided into sanctioned and non-sanctioned periods by Markov switching model. Findings The results show that the pass-through of oil price shocks into Iran’s inflation are time-varying, and there are significant differences at sanction period from other time horizons. An increase in oil price has a positive effect on inflation and its effects are stronger during the sanctions period. It is also observed that the producer price index is more sensitive to changes in the oil price than the consumer price index. The necessity of the government’s earnest efforts to improve international relations to lift the sanctions, along with diversification of exports, and making the economy of Iran independent of oil revenues is obvious. Originality/value In addition to the exogenous oil price shocks, Iran’s economy faces numerous restrictions for its oil exports due to the sanctions. The main purpose of this paper is to investigate the dynamics effects of the oil price shocks on Iran’s inflation in the period 1993:2–2018:2 using the time-varying parameter vector autoregressive (TVP-VAR) model. The dynamics of the results enable us to study the amount and severity of the impact of the oil price shocks on inflation with the distinction of the sanctioned and non-sanctioned periods. The volume of oil export is used to identify the effective oil sanctions.