Economic Research and Perspectives

Economic Research and Perspectives

Modeling the Effects of Economic, Social, and Political Factors on Inflation in the Iranian Economy

Document Type : Original Research

Authors
Fereshteh Karimi 1
Morteza Ezzati 2
Farzin Arbabi 3
1 PhD Candidate, Field or Department: Economics, Faculty of: Management and Economics, University: Science and Research Branch, Islamic Azad University, City: Tehran, Country: Iran
2 Academic rank: Associate Professor, Field or Department: Economics, Faculty of: Economics, University: Tarbiat Modares University, City: Tehran, Country: Iran
3 Academic rank: Assistant Professor, Field or Department: Economics, Faculty of: Economics, University: Tehran Central Branch, Islamic Azad University, City: Tehran, Country: Iran
10.48311/ecor.2026.28389
Abstract
Abstract
from relatively high estimation errors. Consequently, in recent years, research based on Bayesian approaches has expanded considerably. The objective of this study is to model inflation in the Iranian economy under the influence of political, social, and economic variables using advanced econometric methods and to identify the best-performing model. The study period covers the years 2001–2023.
In this research, inflation modeling is conducted by incorporating 43 variables affecting inflation across four categories of models: Time-Varying Parameter Dynamic Model Averaging (TVP-DMA), Time-Varying Parameter Dynamic Model Selection (TVP-DMS), Bayesian Model Averaging (BMA), and Weighted-Average Least Squares (WALS). The aim is to determine the most appropriate model for explaining inflation among these alternatives. Among the examined models, the WALS model is identified as the most efficient.
.Based on the results, 11 variables with the highest impact on inflation are identified, among which the unofficial exchange rate emerges as the most influential factor. Furthermore, the findings indicate that, in explaining inflation in the Iranian economy, economic factors have the greatest explanatory power, followed by political factors and then social factors
Purpose/Aims:
The complex and dynamic nature of inflation has made it a variable influenced by multiple factors. In the economic literature, economic, social, and political factors are recognized as three main categories that affect the behavior of firms and consumers and ultimately shape the inflation rate through macroeconomic instability, heightened uncertainty, and changing expectations. Among these, developing and emerging countries—particularly economies such as Iran—are more exposed to such effects due to fragile institutional structures and vulnerability to non-economic shocks.
In recent decades, Iran has experienced significant political and economic developments, including widespread international sanctions, managerial changes at macroeconomic levels, social crises, and domestic unrest, all of which have imposed multiple shocks on the economy. Accordingly, understanding and analyzing the effects of political, social, and economic factors on inflation in Iran is of particular importance, not only for improving comprehension of the country’s inflationary dynamics but also for designing and implementing effective and sustainable economic policies. Therefore, the purpose of this study is to model inflation in the Iranian economy under the influence of political, social, and economic variables using modern econometric methods and to identify the most appropriate model.
Methodology & Framework:
This research is applied in nature. Data are collected from the statistical databases of the Central Bank of Iran and the Statistics Center of Iran using documentary methods. The study period spans from 1380 to 1402. After data extraction, the values of the variables are calculated and processed using Microsoft Excel, while MATLAB and R software are employed for statistical analysis and result estimation.
The analysis is conducted using Bayesian econometric techniques by introducing 43 variables affecting inflation, grounded in theoretical foundations, within the frameworks of TVP-DMA, TVP-DMS, BMA, and WALS. The objective is to identify the most suitable model for explaining inflation among these alternatives.
Findings:
Among the aforementioned models, the WALS model is identified as the most efficient. Based on the results, 11 variables with the highest impact on inflation are determined. These variables include the unofficial exchange rate, sanctions, liquidity, output gap, net debt of banks to the central bank, budget deficit, oil revenues, interest rate, current government expenditures, human capital index, and corruption. Among these factors, the unofficial exchange rate is identified as the most significant determinant of inflation. The results further indicate that economic factors account for the largest share in explaining inflation, followed by political factors and, subsequently, social factors.
Discussion:
The findings of this study indicate that one of the most important determinants of inflation in Iran is the exchange rate. Statistical evidence from 2018 onward strongly confirms this relationship. Given the heavy dependence of domestic production on imported raw materials and intermediate goods, exchange rate shocks are rapidly transmitted to producer prices. Consequently, increases in the exchange rate lead to higher producer price inflation.
The estimated coefficient for sanctions suggests that weak political and diplomatic relations at the global level, combined with the limited capacity of domestic production to respond to demand, have imposed dual pressure on inflation. This finding highlights the structural vulnerability of the Iranian economy to external shocks. Liquidity growth is identified as the third key determinant of inflation. Excessive liquidity growth, when not accompanied by corresponding real output growth, intensifies inflationary pressures. Similarly, the positive effect of oil revenues on inflation indicates that inflows of oil income, in the absence of sufficient productive capacity to absorb them, are inherently inflationary.
The positive relationship between the output gap and inflation implies an inverse relationship between economic growth and inflation. Empirical evidence from Iran confirms that periods of higher economic growth are associated with lower inflation, whereas economic stagnation coincides with rising inflation. This finding is closely aligned with economic theory. The study also identifies a positive effect of the budget deficit on inflation. In Iran, budget deficits are frequently financed through borrowing from the banking system or monetary expansion, both of which increase liquidity and contribute to inflation through multiple channels.
Another important result is the positive effect of interest rates on inflation. Although increases in interest rates are typically employed to curb inflation by encouraging savings and reducing liquidity, evidence from recent years indicates that inflation has intensified alongside rising interest rates. This apparent paradox can be explained by the prevalence of negative real interest rates in Iran, which limits their effectiveness in attracting deposits and controlling liquidity.
Finally, the results demonstrate that corruption has a positive effect on inflation. Corruption undermines the effectiveness of monetary policy, increases production costs, distorts price mechanisms, and encourages rent-seeking behavior. In contrast, human capital exhibits a negative relationship with inflation. A decline in human capital reduces efficiency, increases social and production costs, weakens governance quality, and indirectly fosters corruption, all of which contribute to higher inflation.
Conclusion & Implications:
Overall, the findings suggest that inflation in Iran is a multidimensional phenomenon driven by structural, monetary, fiscal, and institutional factors. Exchange rate instability, international sanctions, excessive liquidity growth, dependence on oil revenues, persistent budget deficits, ineffective interest rate policies, corruption, and weak human capital all play significant roles in fueling inflation.
From a policy perspective, controlling inflation requires more than short-term monetary tightening. Stabilizing the exchange rate, reducing dependence on imported inputs, reforming fiscal discipline to limit budget deficits, and avoiding inflationary financing methods are essential. Moreover, oil revenues should be managed in a way that enhances productive capacity rather than expanding liquidity. The results also underscore the importance of supply-side policies aimed at promoting economic growth, improving productivity, and expanding domestic production capacity. Strengthening human capital, reducing corruption, and improving institutional quality can lower costs, enhance policy effectiveness, and contribute to long-term price stability.
In sum, sustainable inflation control in Iran necessitates coordinated macroeconomic, structural, and institutional reforms rather than isolated policy interventions.
Keywords
Currency
Inflation
Liquidity
Production
Sanction
Subjects
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