The real interest rate, defined as the difference between the nominal interest rate and the inflation rate, plays a central role in shaping saving behavior, investment decisions, and long-term economic growth. In economies characterized by persistent inflation and administratively determined interest rates, sustained divergences between nominal interest rates and inflation may distort financial intermediation and weaken the growth process. Iran represents a salient case of such an economy, where prolonged periods of high inflation and regulated banking interest rates have frequently resulted in negative real interest rates. This study examines the impact of the real interest rate gap on economic growth in Iran over the period 1991–2023. Employing an Autoregressive Distributed Lag (ARDL) framework, the analysis captures both short-run dynamics and long-run equilibrium relationships between economic growth and key macroeconomic variables, including employment growth, productivity growth, and the real interest rate gap. The findings indicate that a persistent negative real interest rate gap has a statistically significant and adverse effect on long-run economic growth. This effect operates primarily through weakened incentives for real saving, the misallocation of banking resources toward speculative activities, and reduced availability of funds for productive investment. Overall, the results underscore the importance of aligning nominal interest rates with inflation dynamics and managing inflation expectations to promote sustainable economic growth and financial stability in Iran.
Purpose/Aims:
The primary objective of this study is to investigate the impact of the real interest rate gap—defined as the divergence between nominal banking interest rates and inflation—on economic growth in Iran. Specifically, the paper seeks to assess whether sustained negative real interest rates hinder long-term economic growth and to identify the mechanisms through which this effect materializes. Given Iran’s prolonged experience with inflation volatility and administratively set interest rates, understanding the growth implications of interest rate distortions is of particular relevance for monetary policy design. In addition, the study contributes to the existing literature by providing updated empirical evidence for Iran over an extended time span, using a robust econometric framework that distinguishes short-run adjustments and long-run effects.
Methodology & Framework:
This study employs an ARDL modeling approach to examine the relationship between the real interest rate gap and economic growth using annual data for Iran spanning 1991–2023. The ARDL methodology is well-suited to this analysis, as it accommodates variables integrated of different orders, I(0) and I(1), and performs reliably in relatively small samples. Economic growth, measured by the growth rate of real gross domestic product (GDP), is modeled as a function of the real interest rate gap, employment growth, capital accumulation, and total factor productivity growth. Unit root tests are conducted to ensure that none of the variables is integrated of order two. The ARDL bounds testing approach is then applied to assess the existence of a long-run cointegration relationship among the variables. Model robustness is evaluated using standard diagnostic tests for serial correlation, heteroskedasticity, and normality of residuals, as well as parameter stability tests (CUSUM and CUSUMSQ).
Findings:
The empirical results reveal a stable long-run relationship between economic growth and the explanatory variables. Most importantly, the real interest rate gap exhibits a negative and statistically significant impact on economic growth in the long run. Periods characterized by negative real interest rates are associated with lower growth rates, reflecting diminished incentives for real saving and constrained financing for productive investment. By contrast, employment growth and productivity growth exert positive and statistically significant effects on economic growth, underscoring the importance of labor market dynamics and efficiency gains. Short-run dynamics indicate that adjustment toward the long-run equilibrium is gradual, with deviations corrected over time. The bounds test confirms the presence of cointegration, supporting the existence of a meaningful long-term relationship among the variables.
Discussion:
The findings suggest that prolonged negative real interest rates distort the allocation of financial resources within Iran’s banking system. When nominal interest rates fail to keep pace with inflation, households and firms are discouraged from holding real savings in the banking sector, while borrowers are incentivized to channel low-cost credit into speculative activities such as real estate, foreign exchange, and gold markets. This misallocation undermines productive investment, weakens capital formation, and ultimately constrains economic growth. The results are consistent with both domestic and international studies that emphasize the adverse growth effects of interest rate distortions and credit misallocation in inflationary environments. At the same time, excessively high positive real interest rates may also suppress growth by increasing borrowing costs, underscoring the need for a balanced and credible interest rate policy.
Conclusion & Implications:
This study provides empirical evidence that the real interest rate gap has been a key determinant of Iran’s economic growth over the past three decades. Persistent negative real interest rates have reduced real saving, encouraged speculative behavior, and limited the allocation of financial resources toward productive investment, thereby dampening long-term growth. From a policy perspective, the findings highlight the importance of coordinating interest rate policy with inflation dynamics and effectively managing inflation expectations. Policymakers should avoid prolonged periods of negative real interest rates by adopting a more flexible and transparent interest rate policy framework. Strengthening central bank credibility, improving financial supervision, and enhancing coordination between monetary and fiscal policies are essential for fostering sustainable economic growth and financial stability in Iran.