October 2022, No. 101

Cover Story

Inflation, the Ugliest Term in Iran�s Economy

I have already said that inflation is perhaps the ugliest word in the economy, which has been the scourge of our economy for the past half a century.

Dr. Abdolnaser Hemmati, Economist

Iran�s economy will not get anywhere without interacting with the world and without relying on the power of the private sector. The government and its closed economy have nothing but rent-seeking and corruption and the spread of poverty. Our only way is to rely on domestic power to produce and increase the competitiveness of these products in the world. There is no other way. To achieve this goal, what is important is the reform of the economic governance procedure that has been in place for the past six decades. Shrinking the bloated body of the government, ending the government�s dependence on unstable oil revenues, and opening the way for the presence of private sector production in the field of international competition, are the things that we must do, otherwise we will further distance ourselves from the train of economic progress.

I have already said that inflation is perhaps the ugliest word in the economy, which has been the scourge of our economy for the past half a century. Unfortunately, this kind of inflation, like a cesspit, not only disrupts the normal functioning of the economy, but also destroys morality, humanity, honesty and cleanliness at the same time. Inflation can be caused by both supply shortage and demand surplus. On the supply side, the increase in input prices, import restrictions, sanctions, war, drought and natural disasters are the most important factors. On the demand side, the most important factor is the excess demand of the government. Of course, the increase in wages and the price of some assets and the like are also effective. But none of them are as influential as the government�s demand in the long-term trend of inflation.

The government�s excess demand is actually nothing but its budget deficit. Without any exaggeration, the reason for the government�s expenditure exceeding its income is nothing more than spending from the people�s pockets and imposing its cost on the economy in the long run. Unresponsive government equals higher budget deficits. If lucky, in countries like Iran, the government will fill in the holes by selling oil, but if the oil money is not available due to sanctions in sufficient quantity, such as sanctions, and if the government continues extravagancy and economic recklessness, it will create a budget deficit and excess demand. In any case, the budget deficit means excess demand and this means a higher prices. The root cause of the problem of inflation and the incurable pain of Iran�s economy in more than half a century is nothing but extravagancy and overspending by the government.

The misfortune is that this extravagancy is also financed with the powerful money of the Central Bank, which is aggravating the price hikes. The definitive cure for inflation in Iran is, first of all, the government�s financial discipline, the reform of monetary and banking policy should be such that no bank can have a larger balance sheet than the capacity determined based on capital and international indices, and by accumulating risk in the balance sheet create liquidity and excess demand, and finally, the Central Bank should not under any circumstances be forced to pass government�s bad checks.

But what has made the situation more difficult since 2017 is the increasing pressure of the sanctions and its extension until now. The authors of the sanctions in the Trump administration were aware of Iran�s economic conditions, especially the problems of the banking system and the high growth of liquidity despite the stagnation or limited growth in the last two decades. As a result, by putting pressure on Iran�s foreign exchange revenue sources, they actually intended to trigger the collapse of Iran�s economy and cause out of control inflations.

For this reason, in the summer of 2018, when the Central Bank was faced with one of the rarest speculative attacks in the currency market, at the same time, it also faced the discharge of the inflationary effects of the accumulated growth of liquidity, and this caused the inflation jump. The Trump administration had counted on the fact that Iran would resort to selling its foreign exchange reserves to control the exchange rate and in the conditions of cutting off access to foreign exchange earnings, the currency crisis would lead to severe inflation and widespread social discontent.

As a result, the Central Bank realized that it could not target low inflation rates and pursue positive and significant economic growth, so it focused its efforts on protecting foreign exchange reserves and on reducing the intensity of inflation to prevent it from getting out of control. In my opinion, despite the drop in the country�s foreign exchange revenues in 2018 and 2019 to less than 20% of the previous years, inflation did not get out of control, and if the Corona virus and the commercial and economic effects caused by it did not happen, it would have been possible to check the inflation and restore economic growth. We could have done better.

Currently, due to the incomprehensible uncertainty of the nuclear agreement, inflationary expectations are very high, and on the other hand, the severe financial disequilibrium of the banking system has actually severely limited the use of the main tools of the monetary policy maker in the use of the interest rate tool.

Note that without a logical relationship, based on the principles of free international trade with the world, Iran�s economy will not be able to play its real role in the world economy, despite its capabilities such as young and expert workforce, rich land and natural resources, and the existence of energy. When it does not play its real role, it cannot change people�s living conditions continuously and over time.

We are doomed to live a better life and have no choice but to enter the global markets and compete with the world. Sanctions are a destructive category in all fields, and it is necessary to discuss and adopt a foreign policy aimed at serving the overall interests of the country once and for all, The sanctions should be thrown into the dustbin of the rest of the actions against justice and fairness of the Westerners and then concentrate on boosting the economic power and domestic production and improve competitive strength overseas.