The Effects of Nominal and Real Variables on Inflation in Iran

The purpose of this study is to analyze the effects of real and nominal variables in inflation by using a Vector Autoregressive Model (VAR). This model used liquidity growth, exchange rates growth, inflation rate, expected inflation as nominal variable and real output gap as real variable by employing seasonal data. The results show that the cause of inflation is not just the liquidity growth, the chronic inflation is also related to real variables. The VAR results show that in the short-run, nominal variables such as liquidity growth, and exchange rates do affect inflation rate. In the long run, however, stability of prices depends not only on monetary growth but also on the expected inflation and real output gap. The empirical results indicate that liquidity growth is endogenous and nominal variables are related to real output gap. The paper concludes that it is not enough to rely just on monetary policy to control prices in the Iranian economy and in the long run, real output gap should be reduced.