The Nonlinear Effect of Inflationary Expectations and Budget Deficit on Inflation in Iran

Authors
Samaneh Omidpour
Nader Mehregan
Ali Souri
Abstract

Introduction

Inflation, as one of the structural and chronic issues of Iran's economy, has always remained at high levels and has had widespread effects on macroeconomic variables and social welfare. The persistence of high inflation leads to instability in economic, social, and political spheres, to the extent that in some cases, inflationary instability can even result in the downfall of governments. Therefore, understanding the roots of inflation can help policymakers in designing appropriate policies to control and curb it.

Numerous studies have examined the factors influencing inflation and the role of inflation expectations.The literature review revealed that, so far, no comprehensive research has been conducted on the factors affecting inflation, with an emphasis on the nonlinear relationship between inflation expectations and budget deficits within the framework of the New Keynesian approach in Iran. Additionally, the study employs the Hodrick-Prescott filter and the Kalman filter to measure inflation expectations, which is considered an innovative approach. Furthermore, relying on the New Keynesian framework, this study examines the role of the output gap, budget deficit, exchange rate, and inflation expectations in the formation of inflation, specifically identifying the asymmetric impact of inflation expectations.

Method

The aim of this study is to examine the nonlinear effects of inflation expectations and budget deficits on inflation in Iran. For this purpose, the New Keynesian approach and the Nonlinear Autoregressive Distributed Lag (NARDL) method have been used to estimate the model over the period 1988 to 2022. Inflation expectations have been calculated using two methods: the Hodrick-Prescott filter and the Kalman filter.

Results and Discussion

The research findings indicate that the estimated models based on both filters yielded very similar results, demonstrating the robustness of the study's outcomes. Additionally, the results show that variables such as the output gap, inflation expectations, budget deficit, and exchange rate influence the inflation rate. Furthermore, inflation expectations have an asymmetric effect on inflation, where their increase leads to greater persistence and stability of inflation. Moreover, inappropriate fiscal policies exacerbate inflationary pressures by intensifying the budget deficit.

Keywords: Inflationary expectations, budget deficit, inflation, Iran, NARDL.

JEL: E62, E31,H62
Keywords
Inflationary expectations
Budget deficit
Inflation
Iran
NARDL
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