Nexus between economic sanctions and inflation: a case study in Iran

ABSTRACT

Conventional studies have applied dummy variables to analyse the relationship between economic sanctions and inflation while we construct an index which is called Trade-Financial Sanctions (TF index). TF Index is a liner combination of indices which includes trade openness and foreign investment by applying the principal component model. Through the TF index and market exchange rate the impact of economic sanctions on inflation is analysed in the three phases of sanctions; free sanctions, heavy sanctions, and light sanctions. The results illustrate that the TF index decreases inflation when the Iran’s economy experiences free sanctions or light sanctions relative to when the economy is in heavy sanctions. Heavy sanctions create instability in the market exchange rates and widening the gap between the market and the official exchange rates. Furthermore, economic sanctions increase expected inflation among the people and drive higher inflation. Therefore, these results suggest that the government should work more seriously to solve the main obstacles of trade and investment inflows imposed by the economic sanctions.

KEYWORDS:

• Inflation
• economic sanctions
• PCM
• TF Index

JEL CLASSIFICATION:

• E3
• F4

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ Missile/arms industry, Revolutionary Guard Corps, Nuclear industry, Energy/petroleum industry, Banking, Central Bank of Iran, Shipping industry, International trade, Insurance and Foreign firms dealing with Iran.

² Particularly Australia, Canada, Japan, New Zealand, Norway, South Korea, and Switzerland.

³ The Institute for International Economics, Case 84–1 US v. Iran (www.iie.com/topics/sanctions/iran3.htm).

⁴ It is just possible to collect data for some variables from 1970. The last year of data is 2011 as the types of Iranian sanctions are very different and non-uniform compared to previous years. In 2012–2015, Iran could not sell its products especially oil and gas because of the biggest limitations to money transfer. Sanctions have targeted Iran’s Central Bank and other financial institutions. Sanctions cut off Iranian banks from global financial system; international banks which dealt with Iran faced severe restrictions by international community. It made the transferring of oil’s earning back to the country extremely difficult. Moreover sharp declines in oil revenues and industrial production, severe restrictions on shipment and considerable devaluation of the Riyal, caused high rate of inflation in every sectors of Iran’s economy (Kokabisaghi 2018).

⁵ D(TF Index) is stationary and ADF statistic is −8.25 at 1% significance level. The computed TF Index is stationary and the ZA statistic is −4.7 at 10% significance.

⁶ ${\epsilon }_{xt}$ and ${\epsilon }_{yt}$, error terms are belong to original VAR model while $e_{1t}$ and $e_{2t}$, error terms are belong to standard VAR model.