Economic Research and Perspectives

Economic Research and Perspectives

Investigating the Effect of Cyclical Fiscal Policy and Fiscal Sustainability on Economic Growth in Iran: State-Space Model with Time-Varying Parameters Approach

Authors
Hossein Aghilifar 1
Khosrow Piraei 2
Hashem Zare 2
Mehrzad Ebrahimi 2
1 PhD 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
10.48311/ecor.2025.13663
Abstract
In this study, with the aim of evaluating pro-cyclical fiscal policy and fiscal sustainability in Iran, examining the effect of pro-cyclical fiscal policy and fiscal sustainability on economic growth in Iran, and examining the interaction between pro-cyclical fiscal policy and fiscal sustainability in Iran, and using annual data of the Iranian economy in the period 1349 to 1400, state-space models with time-varying parameters, autoregression with distributed lags, and the Kalman filter method are used. The findings of this study show that: First, the Iranian government has adopted pro-cyclical behavior during the period under study by increasing spending during boom periods and reducing it during recession periods, and this approach has exacerbated economic fluctuations and increased the vulnerability of the Iranian economy to exogenous shocks; Second, Iran's fiscal policy during the aforementioned period faced challenges in terms of fiscal sustainability, meaning that the government did not increase its budget surplus sufficiently in response to the increase in debt, which led to excessive growth in government debt and increased fiscal risks; third, pro-cyclical fiscal policy behavior and fiscal unsustainability in Iran have a negative and significant effect on economic growth; fourth, fiscal unsustainability in Iran increases pro-cyclical fiscal policy behavior and exacerbates business cycle fluctuations, and pro-cyclical fiscal policy behavior in Iran also weakens fiscal sustainability.Aim and Introduction

After the global economic recession in 2008-2009, the discussion about countercyclical and procyclical fiscal policies and their effects on the economy began. Countercyclical fiscal policy is applied to reduce economic fluctuations by adjusting government spending and taxes against the business cycle. The aim of this policy is to stabilize the economy and flatten its fluctuations. On the contrary, procyclical fiscal policy strengthens economic fluctuations in the direction of business cycles. On the other hand, fiscal sustainability refers to the government's ability to maintain expenditures, income and public debt at a certain level in the long term without jeopardizing economic stability or facing a fiscal crisis. A sustainable fiscal policy ensures that the government's debt in the long run is at a level proportional to the size of the economy. The main questions of this research are as follows:

Is Iran's fiscal policy countercyclical or procyclical?
Is Iran's fiscal policy sustainable?
What is the effect of cyclical fiscal policy and fiscal sustainability on the Iranian economic growth?
How is the mutual relationship between fiscal sustainability and cyclical fiscal policy in Iran?

Methodology

The evaluation of fiscal policy cyclicality and fiscal sustainability and their determinants have been previously researched. However, the effect of cyclical fiscal policy and fiscal sustainability on economic growth and their mutual relationship has not been covered. This research, has utilized Iran's 1970-2021 annual data and a state-space model with time-varying parameters and an autoregressive distributed lags model as well as Kalman filter method. Moreover, to evaluate Iran's cyclical fiscal policy and fiscal sustainability, the effect of cyclical fiscal policy and fiscal sustainability on economic growth have been investigated. The research also deals with the mutual effect between cyclical fiscal policy and fiscal sustainability in Iran.

Findings

In this research, in order to evaluate the cyclical behavior of Iran's fiscal policy and obtaining the index, a state-space model with time-varying parameters, is estimated in which the real GDP logarithm coefficient varies over time. Then, in order to assess Iran's fiscal sustainability and obtaining the index, a state-space model with time-varying parameters is estimated. Finally, an autoregressive distributed lags model is utilized to estimate the effect of cyclical fiscal policy index and fiscal sustainability index on economic growth, as well as estimating the mutual effect between cyclical fiscal policy index and fiscal sustainability index.

Discussion and Conclusion

The findings of this research show: First, Iran's cyclical fiscal policy index estimated in all years is positive and has not recorded a negative number in any year, which means that the fiscal policy implemented in Iran during the period 1970-2021, was procyclical. In other words, the fiscal policy implemented in Iran has increased the range of fluctuations of cycles and for this reason, it has made the Iranian economy vulnerable to the economic shocks. Second, the estimated Iran's fiscal sustainability index is negative in most years so that the average fiscal sustainability index in the entire period is -0.068. This indicates the unsustainability of Iran's fiscal policy in the period 1970-2021. The trend of the smoothed changes of the time-varying parameter related to the fiscal sustainability index is also downward, which means that Iran's fiscal sustainability has been weakening over time and has moved in the direction of unsustainability. Third, Iran's cyclical fiscal policy index has had a negative effect on economic growth. In other words, procyclical behavior of Iran's fiscal policy has slowed down the economic growth rate. Fourth, Iran's fiscal sustainability index has a negative and significant effect on economic growth. Based on the estimated fiscal sustainability index, unsustainability is evident within Iran's fiscal policy. Therefore, unsustainability of Iran's fiscal policy has weakened economic growth. Fifth, Iran's fiscal unsustainability has increased the procyclical behavior of fiscal policy and as a result, exacerbated the fluctuations of economic cycles. Sixth, the increasing Iran's cyclical fiscal policy index reduces the reaction of the primary balance to the government debt. In other words, the increase in the procyclical behavior of the fiscal policy weakens Iran's fiscal sustainability
Keywords
Fiscal Sustainability
economic growth
Cyclical Fiscal Policy
State-space model

Subjects

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