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Comparing the response of inflation to demand and supply shocks in Iran
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Mona Barzegari Marvasti   , Ali Taiebnia , Ali Souri *1 , Teymur Rahmani |
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Abstract: (15 Views) |
In this study, we examine the dynamics of consumer inflation in Iran, with a particular focus on inflationary shocks, defined as deviations from the long-run inflation path. The objective is to compare the response of consumer inflation to supply-side versus demand-side shocks within the frameworks of price stickiness and information stickiness models. In this context, shocks to the growth of the informal exchange rate are treated as supply (or cost-push) shocks, while shocks to liquidity growth are considered demand-driven shocks. This research does not seek to establish causality. Acknowledging that inflation cannot occur without liquidity growth, we analyze the statistical properties of inflation, exchange rate growth, and liquidity growth. Employing a vector autoregression (VAR) framework, we find that consumer inflation responds more strongly to exchange rate shocks than to liquidity shocks, and that such responses become more pronounced during periods of high inflation. Exchange rate shocks, as the primary cost-push disturbances in Iran’s economy, convey more salient and immediate information for price revisions compared to liquidity shocks, which operate through the demand channel. The latter are transmitted gradually due to limited public understanding of concepts such as base money and liquidity, as well as uncertainty regarding monetary policy objectives. As a result, liquidity shocks do not trigger abrupt inflationary jumps, a behavior consistent with information stickiness models. By contrast, exchange rate shocks signal an erosion of inflation control through exchange rate interventions and imports—particularly under circumstances such as intensified sanctions or declining oil revenues—while directly and significantly raising production costs. Consequently, informational and price rigidities are considerably weaker in the face of exchange rate shocks; price adjustments occur more swiftly and forcefully, producing inflationary surges. Moreover, when inflation expectations intensify, the exchange rate—being relatively flexible compared to other prices—adjusts more rapidly. Thus, exchange rate shocks serve as signals of accumulated inflationary pressures, leading to sharper adjustments in inflation.
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Article number: 1 |
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Type of Study: Empirical Study |
Subject:
Monetary Policy, Central Banking, and the Supply of Money and Credit (E5)
Received: 2025/05/5 | Accepted: 2025/09/15 | Published: 2025/09/23
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