Budget Deficit Financing and Macroeconomic Outcomes: New Evidence from a VARX Model for the Iranian Economy

Abstract

The main goal of the study is to evaluate the impacts of different government deficit financing strategies on GDP growth and inflation in the oil-rich nation of Iran from 1990:1 to 2018:4. The link between the government’s budget deficit and GDP growth is examined using the Explanatory-Augmented Vector Autoregressive (VARX) model. Because of the presence of unmodelled variables in the research, the VARX model was applied. The results of the study indicate that the way that the government finances the budget deficit had a direct impact on GDP growth, such that when the Foreign Exchange Reserve Account (FERA) is for most of the financing, the budget deficit’s impact on GDP growth is positive and its severity is increasing. Although the government’s budget deficit has a positive impact on GDP growth, it becomes less severe when most of the financing is obtained through the Selling Government-Owned Companies (SGOC), and when the sale of Debt Securities (DS) is for most of the financing, the impact of the government’s deficit on GDP growth is positive. The study concludes that there is an insignificant effect of a government’s budget deficit on inflation when most of the deficit is covered by withdrawals from the foreign exchange reserve account. However, the budget deficit has raised inflation when the two other sources of funding have gotten most of the funding. One of the study’s innovations is its investigation of the ways used to finance the government’s budget deficit in oil economies, especially Iran. The use of a VARX model to analyse the impact of the government’s budget deficit on macroeconomic indicators and the severity of that impact is another novel aspect of this research. In the Iranian economy, there is no proper statistical information available about the spending of the budget deficit (especially after 2009). This article concludes with a clear message to policymakers: if the government tends to reduce the share of oil income in financing the budget deficit, increasing the share of debt securities is the best alternative.