Stagflation in Iran

In early October 2013, I received the following questions from a Ms. Maryam Salimi, the Fars News Agency Economic Correspondent, regarding the Iranian economy:

– The continuing increase of liquidity has turned into a major issue in Iran, what do you think is the solution?

– What is the common resolution to overcome Dutch decease (inflation along with recession) and what are your suggestions for Iran to overcome this problem?

– What measures have other countries taken to overcome inflation along with recession? Which measure has been the most successful one? Liquidity injection to promote production, utilize liquidity to control the inflation or other strategies?

– Regarding the current economic situation in Iran, which policy do you suggest is the more appropriate? Demand-side policies or supply-side policies?

– Iran’s economy is facing a paradox of increasing liquidity while the liquidity of manufacturing firms is decreasing, what do you think is the reason for this paradox? What solution do you suggest for this problem?

– Due to sanctions, Iran is facing multiple economic issues such as a decrease in oil sale, what are the strategies and substitutes you suggest?


The following are my responses:

Regarding the interconnection between inflation, liquidity and sanctions, I am aware that most economists and politicians in Iran view liquidity and/or domestic policies as the main culprit, while viewing sanctions and/or external factors as secondary factors. I disagree. I believe that, while liquidity and/or domestic policies certainly have had their share of responsibility, sanctions and/or external forces are by far the most critical factors.

Just as a roof or superstructure of a building stands on its foundation or infrastructure, so does a country’s currency stands on the real values that are generated in that country. Under the gold standard system, which prevailed until WW I, the gold content of a currency determined its intrinsic value. Today, the value content of a currency is no longer defined by gold—at least not directly or entirely—but by the strength of the economy it represents, as measured by what it produces and/or exports. Accordingly, the value of Iran’s currency depends, to a great extent, on the production and/or export of oil. Not surprisingly, when the cruel sanctions of last year drastically curtailed the export of the Iranian oil, and at the same time boycotted International banking transactions, the rial collapsed—from around 10,000 per dollar to 35,000 per dollar in a matter of only a few weeks or months—and inflation skyrocketed.

Excess liquidity and inflationary pressure had existed in Iran long before the brutal curtailment of the Iranian oil and the boycott of its banking system. Yet, inflation was never as bad as it is today; it began “galloping” and became “hyperinflation” only when oil and banking embargoes went into effect nearly a year ago. This is why I believe it is perhaps unfair to direct all the blame for the raging hyperinflation (or other economic ailments) at the previous administration.

I agree that, under certain circumstances, excess liquidity can be inflationary. But I also think that, perhaps for some ulterior motives, the inflationary role of liquidity in Iran is exaggerated. Furthermore, I think that without the abundance of liquidity, and the resulting purchasing power and relatively strong demand, the Iranian economy could have been in a much worse shape. Of course, inflation saps the purchasing power. But the fact that consumers tend to believe that the wages, salaries and subsidies (yaraneh) would be somewhat adjusted to inflation, although minimally, they are not afraid of spending—a fact or factor that has kept the demand-side of the Iranian economy relatively strong or, at least, kept it from collapsing.

Generally speaking, economic forces and political voices that are against welfare state programs tend to use inflation as a means to justify and implement policies of austerity economics. According to these voices, (1) excessive government spending contributes to the growth of the money supply; (2) growth of the money supply automatically leads to inflation; and (3) to control inflation, therefore, requires rolling back government spending, or implementing austerity measures.

This Monetarist, or Neoliberal, view of inflation is largely based on the notorious quantity theory of money which holds that price changes are directly caused by money changes. This “causal” relationship is shown by the rather neat mathematical formula MV=PQ (or P=MV/Q), in which M stands for the quantity of money, V stands for the velocity of circulation, P represents the general level of prices, or a price index, and Q is a measure of physical output. Since the Monetarist theorists assume that V and Q are constant—at least, in the short-to medium-term—and M is simply a means of exchange or circulation, it follows mathematically that any change in M will be automatically reflected in P.

The real economic world is very different from this purely mathematical (indeed, mechanical) formulation. For example, once the dubious assumption of the constancy of Q is relaxed, assessment of the impact on P of a change in M becomes much more difficult. Depending on the magnitude and direction of Q, an increase in M, for example, may increase P, leave it unchanged, or even lead to a decrease of it.

An often-cited case in this context is the German experience of the immediate post-WW II period. Evidence shows that while the volume of cash and demand deposits rose 2.4 times and the volume of bank loans, both short and long term, rose more than ten-fold in the 1948-54 period, this significant rise in liquidity not only did not lead to a rise in the level of prices but it was, in fact, accompanied by a decline in the general level of prices—the consumer price index declined from 112 to 110 during that period. Why? Because the increase in liquidity was accompanied by an even bigger increase in output (Q). This experience goes to show that, if or when used productively, a large money supply does not automatically lead to high inflation.

Contrary to the growth-generating experience in Germany, the United States under President Reagan used recession-generating, or austerity, policies to curb the 1970 inflation. To curtail that inflation, Paul Volker, Chairman of the Federal Reserve Bank under Reagan, embarked on such a tight monetary policy that led to the severe 1980-82 recession, with devastating consequences for the poor and working people, as well as for small businesses and family farmers.

So, the answer to your question, “Liquidity injection to promote production, or utilize liquidity to control the inflation” seems to be that, through carefully-crafted policies, liquidity can be used to achieve both objectives: promoting production while simultaneously, or consequently, bringing down inflation. In other words, it does not have to a matter of either, or; it can be of both.

And this brings me to your next question: “which policy do you suggest is the more appropriate? Demand-side policies or supply-side policies?” Just as liquidity does not have to be either for growth promotion or inflation control, policies of economic revival do not have to be either demand-side or supply-side policies. There are many real world experiences of a balanced growth where both supply and demand were robust: immediate post-WW II experiences of the U.S., Europe, Japan, Canada, and a number of other countries.

Two types of liquidity should be differentiated from one another: liquidity in consumers’ hands (or their income), on the one hand, and liquidity as finance capital, on the other. While an abundance of the former type liquidity can be inflationary, it can also have the advantage of propping up the demand-side of the economy. An abundance of the latter type of liquidity, of finance capital, however, can be harmful when it is not used productively—which seems to be the case in Iran. I suspect that the snowballing growth and accumulation of the fictitious or speculative finance capital is a much bigger source of economic instability, including hyperinflation, than the liquidity as people’s income.

And this leads to your other point: “Iran’s economy is facing a paradox of increasing liquidity while the liquidity of manufacturing firms is decreasing. . . .” The simultaneous co-existence of credit crunch in the real sector and liquidity/credit abundance in the financial sector of the economy is only superficially paradoxical. In reality, it is only true to the character of the stage of finance capital; the stage of the dominance of finance capital where or when the financial oligarchy uses money to generate more money without producing anything real; without bothering with the “messy” world of production. This, by the way, is also the plague of the U.S. and other core capitalist economies: asset-price inflation and parasitic growth of finance capital side-by-side with dormant manufacturing and high rates of unemployment.

Governments in the U.S., Japan and other core capitalist countries possess neither the will nor the power to solve this problem because governments in these countries are largely elected and controlled by powerful financial interests. To avoid this problem, Iran needs to control its monetary, banking and credit system. At a minimum, this requires public, not private, ownership and democratic/transparent control of the banking and credit system. Privatization of banks (and other major industries) in Iran is an ominous development. The mushrooming growth of credit institutions and all kinds of “shadow” banking must be stopped.  Contrary to the claims of their beneficiaries, they do not serve any useful purpose; they simply drain the economy and society, both consumers and producers, of financial resources and funnel those resources into the deep pockets of speculators.

The economists and policy-makers who complain about excess liquidity as the source of all economic ills need to focus on the parasitic growth of the financial sector; not on government spending, or on poor and working people’s subsidies and their meager incomes/wages/salaries.