Economic Research and Perspectives

Economic Research and Perspectives

Fiscal Sustainability in Iran A Markov-Switching Fiscal Regime Change and Time-Varying Parameter Models Approach

Authors
Hossein Aghilifar 1
Khosrow Piraei 2
Hashem Zare 2
Mehrzad Ebrahimi 2
1 Ph. D. Student, Department of Economics, Faculty of Economics and Management, Shiraz Branch, Islamic Azad University, Shiraz, Iran
2 Associate Professor of Economics, Department of Economics, Faculty of Economics and Management, Shiraz Branch, Islamic Azad University, Shiraz, Iran
10.22034/25.1.183
Abstract
Aim and Introduction

A balanced government budget plays a decisive role in the stability of the macroeconomics, and the continuous budget deficit puts the stability of the economy at risk. A budget deficit transpires when the expansion in government expenditures exceeds the growth in government revenue. On the other hand, one of the reasons for the government debt enlargement is the continuous budget deficit. Permanent budget deficit has harmful effects on the economy. Therefore, economists recommend that the government should prevent excessive increase in debt by maintaining a sustainable fiscal policy. Fiscal policy is sustainable when the government reacts to the debt swelling by creating an adequate budget surplus. On the contrary, unsustainable fiscal policy causes crises such as suboptimal allocation of resources, failure in financial markets and high inflation rates. Iran's economy has always been struggling with the permanent budget deficit and high debt stocks. The major motive for this is the dependence of the Iranian government's revenues on the sale of crude oil and its products, because with the decrease in oil revenues, the government resorted to borrowing to compensate for its budget deficit, resulting in debt accretion. Therefore, it is necessary to understand the perspective of fiscal sustainability in Iran. The objective of this research is to assess Iran's government fiscal sustainability and its influential factors by employing annual data of Iran's economy from 1971 to 2022 and by utilizing constant parameter fiscal reaction functions including linear and non-linear models, time-varying parameter fiscal reaction function, Markov-switching fiscal regime change model and fiscal reaction function including control variables.

Methodology

The existing literature about fiscal sustainability in Iran, has mainly examined fiscal sustainability in the framework of constant parameter linear fiscal reaction function. This research assesses different models of fiscal reaction function, such as constant parameter linear and non-linear models, time-varying parameter models and Markov-switching fiscal regime change models regarding Iran's fiscal sustainability. It also evaluates the dominant variables affecting Iran's fiscal sustainability.

Results and Discussion

In this research, firstly, the Iran's government fiscal sustainability is tested through the constant parameter linear and non-linear fiscal reaction functions, and to identify the variables affecting fiscal sustainability, the model including control variables is utilized. Then the Markov-switching fiscal regime change model and the time-varying parameter fiscal reaction function are estimated. Among the constant parameter linear and non-linear models, only the linear model including control variables has a significant debt-to-GDP ratio coefficient, which its sign is negative. Hence, it indicates that the fiscal policy implemented in Iran is unsustainable. The Markov-Switching fiscal regime change model shows the existence of two fiscal regimes, one unsustainable fiscal rgime where the reaction of the primary budget balance to public debt is significant and negative and one sustainable fiscal regime where the reaction of the primary budget balance to public debt is insignificant and positive. Also, the results show that the expected duration of the unsustainable fiscal regime is longer than the expected duration of the sustainable fiscal regime. The results of the time-varying parameter model show that the trend of the smoothed changes of the time-varying parameter is downward during the time, therefore, Iran's fiscal policy has proceeded in an unsustainable direction.

Conclusion

The results of the model including the control variables and the time-varying parameter model and the Markov-switching fiscal regime change model show that Iran's fiscal policy is unsustainable. Also, on the basis of this research findings, the variables of the output gap, the government revenue to GDP ratio and exchange rate fluctuation have a positive impact, and the variables of the government real cyclical expenditure and the old population ratio have a negative impact on the fiscal sustainability in Iran. Based on the results of this research, the government debt reduction has not been the priority of the governments in Iran. This has caused unsustainable fiscal policy which in turn, made the Iranian economy more and more vulnerable with regard to external shocks. While developing revenue sources and reducing dependence on oil revenues, the government should reduce its borrowing and therefore decrease the public debt and take steps towards sustainable fiscal policy to help achieving economic stability and sustainable growth in the long-term
Keywords
Fiscal policy
Fiscal Sustainability
Fiscal Regime
Markov-switching model
Time-Varying Parameter Model

Subjects

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