The effect of external shocks on Iran's oil economy: a BVAR‐DSGE approach

Abstract

AbstractGiven the economy's high dependence on oil revenues as well as oil's influential role in the government's budget, we seek to examine the impact of oil revenue shocks on Iran's economy by means of a DSGE‐BVAR model. To capture the intrinsic features of Iran's economy, we allow for a higher level of rigidity for government current spending as oil revenues play an integral role in public budget allocation to current and construction spending. As oil accounts for a high percentage of Iran's currency revenue, we take it as the sole source of export income. We identify technology shocks, oil revenue shocks, exchange rate shocks and money supply shocks as the main sources of business cycle fluctuations. After estimating the model with quarterly data over the period 1369:1–1392:4, the analysis of impulse response functions indicate that production and inflation responses to shocks confirm factual data and the relevant theories. In response to monetary and oil shocks, output rises in the short term while it falls as a result of a surge in the general price level. Exchange rate shock generates a decrease in output but it increases in the long run gaining support from better investment. Moreover, positive monetary, currency and oil shocks generate an increase in inflation while technology shocks induce a decrease in inflation.