Money and Inflation in Iran: Vector Auto-Regression (VAR) Approach

Iran has suffered from high and fluctuating rates of inflation within the last decades. This paper tries to empirically analyze inflation in Iran and find its main factors through Cointegration approach and Vector Error Correction Model (VECM) during the last two decades. The findings of the research indicate that monetary variables are the most important factors in explaining inflectional process in Iran. In addition to liquidity volume, the roles that foreign exchange rates and imports inflation play are to be noted in inflation in the long run. Although the impact of imports on inflation is reductive, the imports inflation affects inflation fluctuations in the long run. Moreover, the results of testing the monetary theory show that this theory could not fully explain inflectional process in Iran. The changes of money volume in Iran have been mostly under the influence of the government’s financial activities and according to the estimations of this paper money-inflation relationship is not proportional. The findings of the research indicate that the causality relationship in this process is from ‘money’ to ‘inflation’. In fact, the money volume is the cause of the inflation, and not its effect.