Macroeconomic adjustments and oil revenue fluctuations :the case of Iran 1960-1990

Abstract

In an oil exporting developing country the issue of how to stabilise the domestic economy from oil market volatilities has been a big concern for both scholars and policy makers during the last two decades. Modelling the behaviour of key arguments involved in the transmission mechanism of oil revenues into the domestic economy is a necessary introduction to dealing with this problem. On the specification point of view, previous empirical works in this area show little concern over a process that takes the variables back to their steady state positions. This leaves long run equilibrium values of the variables involved in this processes undefined. This thesis attempts to provide a careful analysis with empirical evidence of the issue of the macroeconomic effects of oil revenue fluctuations on key economic variables such as domestic and foreign prices, money demand equation, exchange rates and nonoil gdp growth set in a Dutch Disease framework for the Iranian economy during 1960-1990 period. The analysis, using annual data, employs modern econometric techniques (such as cointegration and error correction) to examine dynamics (short run) and static (long run) components of:these variables in connection with oil revenue fluctuations. Two modified versions of the Purchasing Power Parity and conventional money demand relationships are used to model black market exchange rate and monetary aspects of oil revenue changes, respectively. To model domestic price movements, we experiment with 2 long run equilibrium positions, inverted money demand function and reversed PPP relationship. PPP appears as a valid model of the long run black market exchange rate and domestic prices determination. We also find strong supportive evidence for conventional model of real money balances. The main conclusions are: increases in oil revenue (i) depress black market exchange rate asymmetrically; (ii) suppress domestic inflation directly and then pull it up indirectly through higher foreign inflation and a more depressed exchange rate; (iii) have a contractionary effect on non-oil real gdp growth; and (iv) change real money balances with a small elasticity.