The Inflation–Unemployment Trade-Off Under Stagflationary Conditions: The Case of Post-Revolution Iran

Abstract

In this paper, we estimate a Phillips Curve model for Iran in which expectations of inflation are formed both adaptively and rationally. We measure a significant trade-off between inflation and unemployment. Our results suggest that reaching the five-year plan’s “target” unemployment rate of 7% will accelerate the inflation rate to more than 30%. Likewise, arriving at the plan’s “target” inflation rate of 12% will increase the unemployment rate to about 18%. Given such a trade-off, the plan’s target of achieving lower unemployment rate and slower inflation rate is not feasible. In the oil-based economy of Iran, where the public sector through spending of oil export revenues is the main driver of growth, management of the output gap related to the effect of the aggregate demand on inflation helps ease the unemployment–inflation trade-off in an attempt to create jobs with minimal inflationary pressure. In this context, the key for Iran’s economic stability is a sustained expansion of the productive capacity to create meaningful jobs for its growing labor force and to boost the supply of consumer and capital goods to alleviate inflationary pressures.