Abstract
The real interest rate, defined as the difference between the nominal interest rate and the inflation rate, plays a fundamental role in shaping saving behavior, investment decisions, and long-term economic growth. In economies characterized by persistent inflation and administratively determined interest rates, a sustained gap between nominal interest rates and inflation may distort financial intermediation and weaken the growth process. Iran represents a prominent 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. Using 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 economic growth in the long run. This effect operates primarily through weakened incentives for real saving, misallocation of banking resources toward speculative activities, and reduced availability of funds for productive investment. 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 answer whether sustained negative real interest rates hinder long-term economic growth and through which channels this effect materializes. Given Iran’s long history of inflation volatility and administratively set interest rates, understanding the growth implications of interest rate distortions is of particular relevance for monetary policy design. The study also aims to contribute to the existing literature by providing updated empirical evidence for Iran using a comprehensive time span and a robust econometric framework capable of distinguishing short-run adjustments from long-run effects.
Methodology & Framework:
This study employs an Autoregressive Distributed Lag (ARDL) modeling approach to examine the relationship between the real interest rate gap and economic growth using annual data for Iran from 1991 to 2023. The ARDL methodology is particularly suitable because it accommodates variables integrated of different orders, I(0) and I(1), and performs well in relatively small samples. Economic growth, measured by the growth rate of real 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 are 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. Diagnostic tests, including tests for serial correlation, heteroskedasticity, normality of residuals, and parameter stability (CUSUM and CUSUMSQ), are used to validate the robustness of the estimated model.
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 real saving incentives and constrained financing for productive investment. Employment growth and productivity growth, by contrast, exert positive and significant effects on economic growth, highlighting the importance of labor market conditions and efficiency improvements. The short-run dynamics indicate that the adjustment toward 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 in 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 emphasizing 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, indicating 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 factor influencing Iran’s economic growth over the past three decades. Persistent negative real interest rates have reduced real saving, encouraged speculative behavior, and limited the flow of financial resources toward productive investment, thereby dampening long-term growth. From a policy perspective, the results highlight the necessity of coordinating monetary policy with inflation dynamics and managing inflation expectations effectively. Policymakers are advised to 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 steps toward fostering sustainable economic growth and financial stability in Iran.