Oil Revenue, Government Size, and Inflation in Iran: A Markov Switching Approach

Sedaghat Kalmarzi, Haniyeh; Fotros, Mohammad Hassan

doi:10.22050/pbr.2023.400554.1303

Oil Revenue, Government Size, and Inflation in Iran: A Markov Switching Approach

Document Type : Original Article

Authors

Haniyeh Sedaghat Kalmarzi ¹

Mohammad Hassan Fotros ²

¹ Department of Economics, Razi University, Kermanshah, Iran

² Economics Department, Bu-Ali Sina University, Hamedan, Iran

https://doi.org/10.22050/pbr.2023.400554.1303

Abstract

The Iranian economy is intensely affected by the size of the government and oil income. Oil incomes might influence the relationship between inflation and government size since financing the budget in Iran is based to a significant degree on oil revenues. Due to the significance of government size and oil income on the price level, the oil revenue-government size-inflation nexus in Iran during the period 1991-2021 is considered. Estimation results of a Markov switching model recommend that government size incorporates a significant positive affect on inflation. Moreover, the growth of oil income is found to have a significant negative affect on the inflation. Based on the findings, it appears that there are two regimes being considered: Regime 1, which represents a high inflation regime, and Regime 2, which represents a low inflation regime. Our findings suggest that once in the low inflation regime (Regime 2), there is a moderate chance of remaining in that state. However, if initially in the high inflation regime (Regime 1), there is a higher probability of staying in that state and a lower probability of transitioning to the low inflation regime.

Keywords

Inflation

Oil Revenues

Government Size

Markov Switching Approach

Subjects

Oil and Gas Economics and Management

Abounoori, E., & Nademi, Y. (2010). Government size threshold and economic growth in Iran.
International Journal of Business and Development Studies, 2, 95–108.
Afonso, A., Şen, H., & Kaya, A. (2018). Government size, unemployment, and inflation nexus in eight
large emerging market economies. REM Working Paper, 038–2018.
Alavirad, A., & Athawale, S. (2005). The impact of the budget deficit on inflation in the Islamic
Republic of Iran. OPEC Review, 29(1), 37–49.
Armey, R. K., & Armey, R. (1995). The freedom revolution: The new Republican House majority leader
tells why big government failed, why freedom works, and how we will rebuild America (p. 316).
Regnery Pub.
Bahmani-Oskooee, M. (1995). Source of inflation in post-revolutionary Iran. International Economic
Journal, 9(2), 61–72.
Benhmad, F. (2013). Dynamic cyclical comovements between oil prices and US GDP: A wavelet
perspective. Energy Policy, 57, 141-151.
Berument, H., Ceylan, N. B., & Dogan, N. (2010). The impact of oil price shocks on the economic
growth of selected MENA countries. Energy Journal, 31(1), 149-176.
Bonato, L. (2008). Money and inflation in the Islamic Republic of Iran. Review of Middle East
Economics and Finance, 4(1), 41–58.
Campillo, M., & Miron, J. A. (1997). Why does inflation differ across countries? In Reducing inflation:
Motivation and strategy (pp. 335–362). University of Chicago Press.
Sedaghat Kalmarzi, H. and Fotros, M. H. / Oil Revenue, Government Size, and Inflation in Iran … 41
Carlstrom, C. T., & Fuerst, T. S. (2000). The fiscal theory of the price level. Economic Review, 36(1),
22-32.
Chen, S. T., & Lee, C. C. (2005). Government size and economic growth in Taiwan: A threshold
regression approach. Journal of Policy Modeling, 27(9), 1051–1066.
Cologni, A., & Manera, M. (2013). Exogenous oil shocks, fiscal policies, and sector reallocations in
oil-producing countries. Energy Economics, 35, 42–57.
Ekanayake, H. K. (2012). The link between fiscal deficit and inflation: do public sector wages matter.
Australia South Asia Research Centre, 14, 1-34.
El Anshasy, A. A., & Bradley, M. D. (2012). Oil prices and the fiscal policy response in oil-exporting
countries. Journal of Policy Modeling, 34(5), 605–620.
Esfahani, H. S., Mohaddes, K., & Pesaran, M. H. (2013). Oil exports and the Iranian economy. The
Quarterly Review of Economics and Finance, 53(3), 221-237.
Farzanegan, M. R. (2011). Oil revenue shocks and government spending behavior in Iran. Energy
Economics, 33(6), 1055–1069.
Farzanegan, M. R., & Markwardt, G. (2009). The effects of oil price shocks on the Iranian economy.
Energy Economics, 31(1), 134–151.
Grilli, V., Masciandaro, D., & Tabellini, G. (1991). Political and monetary institutions and public
financial policies in the industrial countries. Economic Policy, 6(13), 341-392.
Hamilton, J. D. (2003). What is an oil shock? Journal of Econometrics, 113(2), 363–398.
Han, S., & Mulligan, C. B. (2008). Inflation and the size of government. Review-Federal Reserve Bank
of Saint Louis, 90(3), 245-267.
Iwayemi, A., & Fowowe, B. (2011). Impact of oil price shocks on selected macroeconomic variables
in Nigeria. Energy Policy, 39(2), 603–612.
Kia, A. (2006). Deficits, debt financing, monetary policy, and inflation in developing countries: Internal
or external factors? Evidence from Iran. Journal of Asian Economics, 17(5), 879–903.
Kibritçioğlu, A. (2001). Causes of inflation in Turkey: A literature survey with special reference to
theories of inflation (p. 43). University of Illinois at Urbana-Champaign.
Kilian, L. (2013). Oil price shocks: Causes and consequences. Annual Review of Resource Economics,
6(1), 133-154.
Kilian, L., & Hicks, B. (2013). Did unexpectedly strong economic growth cause the oil price shock of
2003–2008?. Journal of Forecasting, 32(5), 385-394.
Kilian, L., Rebucci, A., & Spatafora, N. (2009). Oil shocks and external balances. Journal of
International Economics, 77(2), 181–194.
Mehrara, M. (2008). The asymmetric relationship between oil revenues and economic activities: The
case of oil-exporting countries. Energy Policy, 36(3), 1164–1168.
Mehrara, M., & Sarem, M. (2009). Effects of oil price shocks on industrial production: Evidence from
some oil-exporting countries. OPEC Energy Review, 33(3–4), 170–183.
Mohaddes, K., & Pesaran, M. H. (2013). One hundred years of oil income and the Iranian economy: A
curse or a blessing? (No. 4118). CESifo Working Paper: Empirical and Theoretical Methods.
42 Petroleum Business Review, Vol. 8 (2024), No. 2
Nademi, Y., & Winker, P. (2022). Non-linear effects of government size on inflation in OPEC countries:
A threshold panel approach. Iranian Economic Review, 26(1), 199–214.
Sargent, T. J., & Wallace, N. (1981). Some unpleasant monetarist arithmetic. Federal Reserve Bank of
Minneapolis Quarterly Review, 5(3), 1-17.
Sargent, T. J. (1982). The ends of four big inflations. In Inflation: Causes and effects (pp. 41–98).
University of Chicago Press.