This paper presents an error-correcting macro-econometric model for the Iranian economy using a new quarterly data set over the period 1979Q1–2006Q4. It builds on a theoretical long-run growth model developed by the authors for major oil exporting economies. The core variables included in this paper are real output, real money balances, inflation, exchange rate, oil exports, and foreign real output, although the role of investment and consumption are also analyzed in a sub-model. The paper finds clear evidence for the existence of two long-run relations: an output equation as predicted by the theory and a standard real money demand equation with inflation acting as a proxy for the (missing) market interest rate. The results show that real output in the long run is influenced by oil exports and foreign output. However, it is also found that inflation has a significant negative long-run effect on real GDP, which is suggestive of economic inefficiencies and is matched by a negative association between inflation and the investment–output ratio. Finally, the results of impulse responses show that the Iranian economy adjusts quite quickly to the shocks in foreign output and oil exports, which could be partly due to the relatively underdeveloped nature of Iran’s financial markets.

JEL Classification: P36, B22, F14, C2, E4