Investigating the effect of global prices on the dynamics of Iran's economy with an emphasis on food inflation in the framework of dynamic stochastic general equilibrium model

Document Type : Research Paper

Authors

1 Assistant Professor of Economics, Gonbad Kavous University, Gonbad Kavous, Iran.

2 Economic faculty, Tehran university, Tehran, Iran

Abstract

Purpose: Commodities are very important as production inputs and raw materials in industrial and agricultural productions as well as for providing basic needs in different countries. The global price shocks of commodities affect business cycle fluctuations of countries and their spillover effects on key macroeconomic variables such as inflation, production, and exchange rate. So, many researchers and policymakers in recent years, especially in the era of COVID-19 and the war between Ukraine and Russia, emphasize this issue. In the first step, global prices increase domestic inflation through increasing the price of food imports and then increasing the cost of household consumption basket. In the next step, the real sectors of the economy are affected, and macroeconomic balance disruption appears through various channels, such as trade sector, financial systems and investment. Note that the variation of production depends on the economic structure, the size of the economy and country's openness degree of trade. Although macroeconomic variables such as inflation and production are influenced by global price shocks, it is difficult to measure their impulses. So, in this study, the impact of global commodity prices (oil and foods) on Iran's economy is examined with the dynamic DSGE approach.
Methodology: This research investigates the effects of global commodity (oil and foods) prices on Iran's macroeconomic variables (such as inflation, production, consumption and employment) with an emphasis on the food sector during the period of 2001-2021. For this purpose, the effect of global price shocks on inflation and growth (based on the impulse response function) is presented via the DSGE approach. So, The main variables of this study include oil price (OILP), world food price (WFP), real exchange rate (REER), wholesale price index (WPI) and domestic food price index (FOODP). In this study, a two-country DSGE model is designed with an emphasis on the country that exports oil and imports food. The model is designed in such a way that the impulses on the supply and demand side of oil and food can be identified on the macroeconomic variables separately. In fact, the research model is set to follow Oladouni (2020) in the form of a two-country open stochastic dynamic general equilibrium model based on the new Keynesian perspective. This model involves households, firms (one final producer and three intermediate firms), foreign sectors (foreign firms and importers), the government and the central bank. The innovation of this research is that, in addition to endogenously considering oil production, it has investigated the other factors affecting the domestic inflation. In this model, it is assumed that the real GDP is followed in a random walk process, and equilibrium real interest rate and equilibrium real exchange rate are univariate time series models. The inflation rate is explained based on the new Keynesian Phillips curve.
Findings and Discussion: Using the seasonal data of 2001-2021 and the Bayesian estimation technique, this study indicates that the changes in global food prices are an important factor in overall inflation as well as food inflation in the country. More precisely, the results show that, in the first step due to the increase in oil exports, the oil price impulse leads to an increase in the total production, employment and consumption temporarily, but, after a period, changes in the exchange rate lead to a decrease in exports of domestic goods and an increase in the import of intermediate goods. This finally causes a decrease in production and an increase in inflation, especially food inflation in the short term. However, in the long run, they converge to their equilibrium values. The important point in this situation is that the amount of consumption of tradable (imported) edible goods is reduced and replaced by non-tradable ones. The results also show that the global food price shock increases the price of tradable food products. An increase in the price of tradable food goods increases the price of non-tradable ones. Moreover, the decrease in money supply through the exchange rate channel leads to an increase in the demand for non-food tradable goods, their prices, and inflationary pressure. The poorer a country is, the greater the share of non-tradable food commodities in inflation, and the more the inflationary effects of a global food price shock.
Conclusions and policy implications: It is clear that identifying the causes of inflation, especially food prices, is one of the key aspects of policy-making in order to deal with crises, as in a situation of war, disease or stagflation. As the results showed, global commodity prices, along with exchange rate changes, are transferred to the domestic economy and affect the macroeconomic variables such as inflation and output after about three months. So, it will be important for the government to control the inflation and make efforts to provide enough food products, considering the 3-month opportunity before the shock. In this regard, it is suggested that, to control inflation at least in a short term in the field of trading inputs and agricultural products, some instruments should be used to limit their export. In addition, it is suggested that, in long-term planning, the monetary and banking laws of the country be reformed and the government's dominance over the monetary policy be reduced, thus reducing the negative effects on the real sector.

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References

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The Journal of Economic Policy
Volume 16, Issue 31
September 2024
Pages 187-231

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