Role of Economic Policy

Role of Economic PolicyRole of Economic Policy

Iran's economy has experienced unusually tough times over the past five years. There is a consensus along with concern among observers and experts that the economy is now saddled with stagflation unseen in recent contemporary history.

A variety of factors have created and contributed to the present unacceptable state of affairs, which the government is committed to address with the full force of the law and other instruments at its disposal. These factors inversely affected the economy by expanding aggregate demand and contracting aggregate supply. Energy price reforms, or for the matter the unprecedented subsidy reform plan, led to the increase in production costs, and by extension, put added pressure on aggregate supply.

Meanwhile, one ambitious program -- to build houses for low-income households -- financed with direct credits from the Central Bank of Iran, stimulated aggregate demand and pushed up prices. In addition to these domestic developments, stricter western sanctions were imposed on oil exports and banking/financial transactions due to the dispute over Tehran's nuclear energy program.

Put together, these factors   further undermined access to hard currency reserves and destabilized the already volatile foreign exchange market.

After President Hassan Rouhani took office and with the introduction of economic reforms, the economy slowly started recovering from the stagflation. On the one hand, the inflation rate which had crossed the colossal 40 percent barrier in October 2013 fell to 25 percent last July. This was due partly to improvement in inflationary expectation among businesses and market pundits and a semblance of stability in foreign exchange rates which is traditionally an effective nominal anchor in the short-run. On the other, after two years of negative growth when the economy shrunk to new lows, there are signs that come March real activity will return creating better space and scope for troubled businesses, industries and the saturated job market.

Despite these hopes and achievements in stabilizing the economy in short-term, there are uncertainties about the long haul. A case in point is the subsidy reform process. The government, in the second phase of the subsidy reform plan, increased the price of natural gas, electricity and petrol which will have a bigger negative impact on production costs and aggregate supply.

Moreover, the economic sanctions are still lingering around, and access to foreign reserves is almost as restricted as it was a year ago. However, big amounts were repatriated to Tehran over the past few months, following the initial agreement with six major powers over the disputed nuclear program. All said and done, the future remains far from certain.

Since the nature of shocks hurting the economy is diverse, the government too should tackle them with different policies. One primary step would be for the government to initiate effective measures to improve productivity. This could be followed by creating and expanding a business-friendly atmosphere to help facilitate decent GDP growth in the medium-term, and moving on the path to put a permanent end to the unfair and unjust sanctions.