Examining government revenue shocks and their effects on macroeconomic variables Using DSGE Model

Abstract
The present study investigates government revenue shocks including oil revenues, tax revenues, and revenues arising from an increase in the exchange rate (exchange-rate shock) as well as their effects on macroeconomic variables. To this end, a Dynamic Stochastic General Equilibrium (DSGE) model was developed for the Iranian economy under open-economy conditions using the data covering the period from 1989 to 2021. According to the simulation results, an increase in the exchange rate raises the marginal costs of domestic firms, thus reducing the imports of intermediate, capital, and consumer goods as compared to their steady-state paths. The output also exhibits a decreasing and subsequently increasing pattern as compared to the steady-state path. A positive oil shock, through its effects on the monetary base and government expenditures, increases aggregate demand and inflation, which, in turn, leads to an increase in non-oil output as compared to its steady-state path. Following a positive oil shock, non-oil exports decrease, while imports of all the three categories of goods, namely intermediate, capital, and consumer goods, increase.. A positive tax shock reduces households’ disposable income, leading to a decline in household consumption of both domestic and imported goods. Consequently, aggregate demand decreases, and output follows a downward trajectory. Furthermore, all the three shocks result in a reduction in the government budget deficit and government debt. According to the results obtained from the welfare loss function, the exchange-rate shock generates the greatest welfare loss compared to oil-revenue and tax shocks.
 
Extended Abstract
 
Purpose: Statistical and historical evidence shows that the Iranian government utilizes three main channels to increase its resources. These three scenarios are taxes, oil revenues, and an exchange rate increase. Each of the financing scenarios affects the nominal and real variables of the economy through different channels. The purpose of this study is to examine government revenue shocks and their impacts on macroeconomic variables.
 
Methodology: This study utilizes the stochastic dynamic general equilibrium method to analyze the effects of shocks originating from three government income sources. Furthermore, the losses resulting from these shocks are compared. The model considers six agents including household, intermediate goods-producing firms, the trade sector in both non-oil exports and imports, the oil sector, government, and the central bank. The data used in the simulation, covering the period from 1989 to 2022, were obtained from the Time Series Information Database of CBI and the Data and Statistical Information of the Statistical Center of Iran. The parameters have been calibrated by previous studies and by considering geometric means of variables.
 
Findings and Discussion: Macroeconomic effects of an exchange rate shock: The initial consequence of the exchange rate increase is a decrease in the import of consumption goods, investment goods, and intermediate inputs. The reduction in the import of these goods is not uniform. The decrease in the import of intermediate goods and intermediate inputs is less pronounced than that of consumption goods. This is because, when the exchange rate increases, the production sector cannot immediately and fully reduce its orders for intermediate inputs. As time passes and the price of domestic goods rises, leading to an increase in consumer prices, the value of all types of imported goods tends to be stabilized. Additionally, the rise in the relative price of imported goods contributes to an increase in inflation from its equilibrium level. Also, the positive exchange rate shock increases the competitiveness of export goods by reducing the export price index and leads to an increase in non-oil exports from the equilibrium level. Production also decreased initially due to the increase in the marginal cost of firms. But over time, it increased due to the increasing demand of domestic and foreign households for domestic goods. The foreign exchange reserves of the Central Bank initially increased by 4%, which resulted in an expansion of the monetary base. However, over time, the monetary base gradually declines and returns to its equilibrium level. In addition, this shock leads to a reduction in the government budget deficit and a reduction in government debts. 
Macroeconomic effects of oil revenue shock: As oil revenues increase, with a significant portion of this income being sold to the central bank, the foreign reserves of the central bank initially rise by 3% from its equilibrium level. An increase in the net foreign assets of the Central Bank leads to an increase in the monetary base. Additionally, an increase in the net foreign assets of the central bank also results in a reduction in the nominal exchange rate. Inflation also increases due to an increase in the monetary base, and the real exchange rate decreases due to thea decrease in the nominal exchange rate. The decrease in the real exchange rate also leads to a decrease in non-oil exports and an increase in imports. Therefore, the import of consumption goods, investment goods, and intermediate inputs increases.
 The positive effect of the oil shock on the supply side causes prices to rise and creates an incentive to increase production in the non-oil sector, so intermediate goods-producing firms tend to use more labor and capital. Due to a limited labor force, firms offer higher wages, leading to increases in both wages and capital rents. Because the government budget is dependent on oil, an increase in oil revenues reduces the government budget deficit. Additionally, a positive oil shock leads to the increase of the government's investment expenditure. The investment increases due to the increase in the government's investment expenditure and the increase in imports.
Macroeconomic effects of tax shock: An increase in taxes results in a reduction in household income, leading to decreased consumption of both domestic and imported goods. This, in turn, causes a decline in aggregate demand, resulting in lower output and employment. Reducing production means reducing the utilization of production factors, including capital, labor, and intermediate inputs. Also, with a decrease in production, inflation increases, which leads to a decrease in the real rental rate of capital. The increase in taxes has resulted in reduced motivation and labor supply, leading to a 0.15% increase in wages. This shock will also boost government revenues, reduce the budget deficit, and decrease government debts. In response to the increase in revenues, the government raises its consumption expenditures.
 
Conclusions and Policy Implications: Based on the model's results and the more volatile effects of the exchange rate on macro variables, it is advisable for the government to refrain from implementing policies that increase the exchange rate in pursuit of more revenues and decrease the budget deficit.