Analysis of domestic price and inflation determinants in Iran (as a developing oil-export based economy)

Abstract The objective of this study is to examine and investigate both behaviour and determinants of domestic prices and inflation rate in Iran as a developing oil export based economy. I apply two models; the first model is for investigating the main determinants of domestic prices while the second model considers the main determinants of inflation rate. The period of study is from 1973 to 2008. Some econometrics techniques such as unit root test, cointegration test, ECM model and causality test have been used. The first model is constructed according to the studies that mostly have tried to investigate the inflation in other developing and developed countries. The results indicate that foreign prices, GDP, exchange rate and the two dummy variables DT80 and DT88 ( for capturing the structural break which have been caused respectively by the war with Iraq and the subsequent reconstructions after war) have significantly affected the domestic prices in Iran. Furthermore, in the short run the main determinants of domestic prices have been foreign prices and DT88. In contrast with Aljebrin (2006) who has considered this model for other developing oil export based economies our estimations of first model demonstrate some acceptable results about the factors that have affected the domestic prices of Iran. In the second model I apply the model which has suggested by Aljebrin(2006) to investigate the inflation in developing oil based economies. The results show that money growth, oil production growth, non-oil GDP growth and two dummy variables DT80 and DT88 have affected Iranian inflation in long run. Moreover in the short run the main determinants of inflation have been non-oil GDP growth and DT88. Our results imply that the rapid development of the non-oil sector and performing some useful policies for restructuring the economy such as diversifying the economy from the oil sector will strengthen the economy and reduce the importance of oil production as a source of inflation.