Investigating the Causality between Money and Inflation in Iran: a MS-VAR Approach

Document Type : Research Paper

Author

Associate Professor of Economics at Institute for Humanities and Cultural Studies

Abstract

Before Post-Keynesians, theories on the relationship between money growth and inflation had largely been shaped around the positive relationship and that money causes inflation. Then the idea was raised that there may be no correlation between money growth and inflation, or in case of existence, the causality is reversed. In the Iranian economy money growth and inflation were volatile during last six decades and have experienced different situations. Considering theoretical and empirical literature and the experience of volatile money growth and inflation in Iran, this issue is important that whether the causality between money growth and inflation is constant, or, in years of high inflation, reverse causality can play a significant role in destabilizing money dynamics? In this regard, this paper performs a nonlinear empirical test using Markov Switching Vector Autoregressive model. Findings show that three different regimes can be identified during 1961-2017 period. In the zero regime, where broad money growth is noticeably greater than inflation, there is a one-way causality from money growth to inflation. In regime one, where both variables have experienced slower rates, there has been a bilateral causality between them, and in regime two, where inflation rate has been substantially high, a one-way causality is seen from inflation to money growth. The policy implication of this study is primarily to control money growth and secondly to control other determinants of inflation in high inflation periods to prevent the reproduction of liquidity growth or the reverse causality.
 

Keywords

References

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new economy and trad
Volume 15, Issue 3
March 2021
Pages 3-26

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History

  • Receive Date: 01 May 2020
  • Revise Date: 25 July 2020
  • Accept Date: 22 August 2020

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