REASSESSING THE EFFECT OF FISCAL AND MONETARY POLICIES IN IRAN: THE ST. LOUIS EQUATION REVISITED

Abstract

The purpose of this study is to observe effect of fiscal and monetary policy actions on Iranian economy. The famous St. Louis equation, an econometric model with lagged independent variables, is key model for this study. Interestingly, findings are converse to what scholars found when examining Western countries, especially United States. With regard to Iran's case, monetary policy is much less effective than fiscal policy in stimulating permanent economic growth. It is suggested that government interference is reason. Furthermore, these findings support equation's general validity and its application, due to its parsimonious construction.Keywords: Fiscal Policy, Iran, Monetary Policy, St. Louis Equation, TRAMO/SEATSJEL classification: E52, E62, E63(ProQuest: ... denotes formulae omitted.)1. INTRODUCTIONFor over thirty years, Iranian economy has been under great pressure, with sanctions and embargos applied by many western countries (Ilias, 2009; gives an interesting summary). As a result of such pressure, a progressively more intense belief, on part of most Iranian politicians and various sectors of public, is that because government is responsible for stabilizing and stimulating economic growth, it is also therefore obliged to explore all financial and political possibilities without exception or restriction. This attitude could potentially also foster an excessive and inefficient use of fiscal assets by Iranian government. Notably, some politicians could use such policies more to pursue their own political objectives, rather than for public and national benefit. Mazarei (1996) argues that populist economic policies have mainly influenced Iran's economic conditions since post-revolution period after 1979. This issue is amplified by fact that Central Bank's monetary policy is controlled by government. Naghshineh-Pour (2009) criticizes dependant central bank policy with regard to Iran's banking problems. He (on page 2) comments further: A government-dependent central bank often tenders short-sighted politicians to try to wrangle a temporary economic roar to promote themselves. These concerns imply an insignificant economic effect induced by monetary actions. Although such concerns are frequently voiced, they are rarely investigated. Nevertheless, this study aims to show that these concerns are justified as empirical results demonstrate.The St. Louis equation may no longer be revolutionary and provocative, but so far, its critics have still failed to present any clear evidence to refute it. One notable advantage of model is indeed its simplicity, especially when reliable data is scarce. For instance, due to information barriers and restrictions in many non-western countries, such a model can be an excellent tool, especially for a qualitative assessment of impact of fiscal and monetary actions on economic growth. Certainly, some scholars may criticize that model's simplicity is what makes it inadequate in analyzing policy effects on complex economics, especially for case of developing countries. Indeed, it's debatable whether complexity can solve this issue. Hence, Summers (1991) points out that the empirical facts of which we are most confident and which provide most secure basis for theory are those that require least sophisticated statistical analysis to perceive. The St. Louis equation is certainly an unsophisticated approach and hence a good analysis tool for those scholars who agree with Lawrence Summer's point of view. The results of study are presented in third section of this paper, which is followed by a discussion. In last section, we derive some conclusions.The paper is organized as follows. Section 2 introduces issue of Iran's subsidized economy. Section 3 presents a short literature review regarding St. Louis equation. The following Section 4 introduces model and data while Section 5 presents results and robustness checks. …