Double-digit inflation rates, either those hovering around 18-20% in the years prior to the fiscal 2018-19, or 40-50% in subsequent years, are triggered by the government’s insistence on fulfilling its responsibilities by printing money. This shows that the cause of all double-digit inflation is “seigniorage” and not the budget deficit.
Seigniorage is the difference between the face value of money — both paper bills and coins — and what it costs to produce it. It may be counted as positive revenue by a government when the money it creates is worth more than it costs to produce. This is the case of Iranian government, which may not directly, but indirectly use this method to finance the costs of its obligations and duties.
Kamran Nadri, an economic expert, prefaced his article for the Persian daily Donya-e-Eqtesad with this note. A translation of the text follows:
Iranian governments use loans or bank facilities to fulfill their obligations, or those mandated by the parliament. As the lion’s share of the government’s debts to the banking system remains unpaid, banks approach the central bank to collect their claims. As banks demand their claims from the central bank instead of the government, “powerful money” is created indirectly; this process is exactly what happened both in the years before and after 2018-19. In fact, the same trend led to the government “monetizing” their problems and trying to solve their problems through “creating money”.
From this viewpoint, there is no special difference between the years before and after 2018-19. However, the reimposition of US sanctions in 2018 increased the government’s need to monetize their duties and obligations, which increased money creation. This is the same reason for the rise in money supply growth in recent years, which pushed the average inflation rate from 18-20% to 40-50%.
If you look carefully at the causes of inflation in Iran, you’ll realize that the main reason behind inflation in Iran has always been the “monetization” of government’s obligations and duties. But it should be noted that this process is taking place surreptitiously; governments have always denied borrowing from the central bank.
However, a closer look will show that this process is taking place indirectly; the only difference between the years before and after 2018-19 is the intensity of the monetization of government’s tasks and duties given the severity of sanctions.
Two Other Drivers of Inflation
There are two other causes of the escalation of inflation: inflationary expectations and misguided interest rate policies.
Following Donald Trump’s victory in the 2016 US presidential elections and his threat to withdraw from the Joint Comprehensive Plan of Action in the same year and the eventual US withdrawal, inflationary expectations increased in Iran. Before 2018-19, the government was able to control inflationary expectations, thanks to oil revenues and the stabilization of the national currency, but this process was reversed and inflationary expectations reduced demand for local currency after the US withdrawal from JCPOA. The supply of rial increased as more money was being created by the government. This decline in demand and increase in rial supply fueled the devaluation of the national currency, the rise in the foreign currencies’ exchange rate and inflationary expectations.
The misguided policy of “stabilizing the interest rate” was also in play. Instead of its adjustment with the inflation rate, the interest rate has always remained fixed in Iran. But after the US quit JCPOA, the government followed this policy even more strictly.
Obviously, Iranian households do not want to keep their assets in the form of the rial in banks; they prefer to have assets in the form of foreign currency, gold, housing and cars. This policy shows that governments are more determined to monetize their expenses and they seek to reduce the costs of this decision. In other words, with these policies, they were acknowledging that there are problems in the economy that we want to solve by providing low-interest loans.
Therefore, the following three reasons are behind the soaring inflation rate:
1. The government’s crying need for monetization of their duties and obligations following the reimposition of sanctions.
2. Intensification of inflationary expectations, and
3. The government’s persistence on implementing wrong policies regarding interest rates.
These three drivers of inflation are still in effect. As a result, inflation will continue its uptrend in the years to come. This cannot be seen as a sign of Iran becoming a carbon copy of Venezuela in the next two years because, fortunately, the speed of monetary conversion in Iran — the conversion of rial into other assets by the people — is very high and this prevents governments from generating more income by monetizing their duties. In fact, the growth rate of money itself shows that people are quick to react to inflation.
The government’s debts (both domestic and foreign) are not that large and this reduces the government’s need to create money; Venezuela had run up a huge foreign debt before hyperinflation.
In addition, Venezuela did not have significant tax revenues in the years before hyperinflation whereas Iran benefits from this opportunity. Note that the continuation of this process will drive up inflation in the fiscal 2023-24 and 2024-25.
If the misguided economic policies remain unresolved along with social dissatisfaction, Iran is likely to see a quasi-Venezuelan inflation in the fiscal 2025-26.
