Source of Stagflation in an Oil-Producing Country: Evidence from Iran

A stagflationary period is a period during which an economy experiences a decline in the level of production and a rising price level. In industrial countries stagflation is mostly caused by a sudden increase in oil prices such as those that took place in 1973 and 1979. What may contribute to stagflation in an oil-exporting country that does not experience an oil price shock? Since the advent of the Islamic revolution in 1978-79, Iran has been experiencing inflation and a declining domestic production. Besides the revolution and Iran-Iraq war, which initially resulted in a decline in oil production (and therefore in GDP), there is a new feature of Iranian economy that deserves attention, namely, a depreciating currency. After 1978-79, depending upon the type of transaction, Iran relied upon multiple exchange rates that were much lower than the parallel market rate. The multiple rates not only resulted in imbalances among prices of imports versus domestic goods, but favored some special interest groups. These factors forced the Iranian Central Bank to realize the dominance of the parallel market rate and as recently as the spring of 1993 to abolish all multiple rates and adopt one single floating rate (the parallel rate). It is our conjecture that massive depreciation of the Iranian rial is one of the sources of Iran's current stagflation. To prove this, we need to show that depreciation is not only inflationary but also contractionary. The first issue has already been investigated by Bahmani-Oskooee (1995), who provided strong empirical results showing the inflationary