The Lure of Inflation

About a hundred days ago, in the heat of the presidential election campaign, First Vice President Es’haq Jahangiri faced the state TV camera and said, “The inflation rate fell to 6.8% from 40% under President Hassan Rouhani. That’s why today no one talks about inflation. No one promises to reduce the inflation rate, because what we did was no mean feat.”

Financial Tribune- About a hundred days ago, in the heat of the presidential election campaign, First Vice President Es’haq Jahangiri faced the state TV camera and said, “The inflation rate fell to 6.8% from 40% under President Hassan Rouhani. That’s why today no one talks about inflation. No one promises to reduce the inflation rate, because what we did was no mean feat.”

Two weeks ago, Akbar Torkan, the president’s chief advisor, told another TV channel that to have a robust economy, monetary policy designed to squeeze out inflation might not be an option.

Has anything changed over the 100 days? One thing has. Monthly reports by the Central Bank of Iran show the average goods and services Consumer Price Index for urban areas has once again bloated into double-digit rates in June, increasing by 10.2% and 10.3% in the last two months.

Torkan belongs to a group of statesmen who believe that for the economy to thrive, the government needs to loosen its grip on money and hence inflation. Under a single-digit inflation rate, they believe, the central bank should lower interest rates and grant cheap loans to producers. 

Unlike Torkan and his ilk, most economists dismiss the argument.

Masoud Karbasian, the new minister of economic affairs and finance, had recently told the weekly that the time for having economic growth by setting up “inflation-oriented businesses” is gone and that he plans to protect the outgoing government’s achievement in curbing the inflation.

The Persian weekly Tejarat-e Farda asked two economists, Pouya Jabal Ameli and Reza Boustani, about the relation between inflation and economic growth. Their views are as follows:

It is possible to have economic growth without causing inflation; the experience of the past three years proves this fact.

When the country entered recession in the fiscal 2011-12 and the point-to-point inflation rate reached unbearable levels of 40%, there were no signs of economic growth. On the other hand, despite the decrease in inflation rates under President Rouhani, the country saw strong economic growth, which is a strong indication that an inverse relation exists between economic growth and inflation.

Some consensus suggests that inflation is conducive to economic growth and that there is a positive link between inflation and economic growth, but only for a short time. In other words, expansionary policies would lead to higher inflation and economic growth in the short run, but in the long run, such policies have no effect on production and economic growth.

The idea of neutrality of money, also called neutral money, stipulates that changes in money supply only affect nominal variables and not real variables. In other words, an increase or decrease in money supply can change the price level but not the output or structure of the economy.

In modern versions of money neutrality theory, changes in money supply might affect output or unemployment levels in the short run only, but neutrality is still assumed in the long run after money circulates throughout the economy.

There is another view suggesting that the impact of money on production is negligible even in the short run. To believers of this discourse, money is superneutral, with neither inflation nor change in inflation affecting non-monetary variables.


Inflation and economic growth might even forge an inverse relation in economies hit by massive inflation rates. Studies show [contractionary] policies designed to reduce inflation might boost production. The logic behind this unnatural relation is that, big inflationary bouts strip economic operators of decision-making ability. People second guess investments they are willing to make.

When inflation decreases, business owners will have greater power and motivation for manufacturing activities, whereas runaway inflation prompts people to find safe shelters for their capital and these shelters are nothing but foreign exchange and gold markets in Iran. Manufacturing activities fail to attract investment. Here, people are under the delusion that they have accumulated capital whereas they have only protected their purchasing power against inflation.   

Another reason behind the belief that curtailing inflation would help economic growth is that those in positions of authority tend to employ pricing strategies when inflation increases. Such strategies disable mechanisms of market, lead to inefficiency and, ultimately, stymie growth.

Those who beat the drum for higher inflation rates have their sights set on CBI’s loans and lines of credit. Although credit lines raise inflationary risks for people, they are financially rewarding for those who get them. In other words, those who take out loans under the pretext of production reap profits for which people pay the costs.  Other than this, there is no logic behind asking for ruinous inflation rates higher than the current 10%, the rate which is five times more than the target of central banks across the world.

The first obvious manifestation of all the efforts of the government of President Hassan Rouhani, from the nuclear deal with world powers to economic policies within the country, was the moderate inflation in the past couple of years.

Long-lasting durations of high inflation are often the result of government incompetency in economic affairs. That the 11th government has managed to reduce inflation is a clear indication of its effective policies.

The economic stability of the country, which surely owes to the subdued inflation, brought to light the real problems with the economy like those in the banking system. We were blind to our dysfunctional financial system without the reined-in inflation. But more should be done to safeguard this stability. Economic operators seem to be unsure about the viability of this moderate inflation.

Over the decades, inflation has moved up and down, but rising inflation has always been caused by excessive monetary expansion. Inflation has never helped economic growth. And the reason behind those who approve of higher inflation rates is that they are in the habit of throwing money at all economic problems.

With the country’s troubled banking system, the executives who allocated loans for every project feel their hands are tied up.

They can’t break ground on new projects on a daily basis anymore. So they try to turn the clock back to the old days. But the fact of the matter is that old projects did not help job creation or economic growth in the past and will not do so today.

Indefensible comments made by officials who pitch higher inflation rates are politically-driven.

The only economic achievement of President Rouhani was containing the runaway inflation, which benefited the government, society and future of the country, and I don’t think he will let this significant breakthrough slip through his fingers and risk losing the control of inflation.

Financial Tribune
Publish Date: Aug 21, 2017