The first warning pertains to consequences of excessive burgeoning of liquidity was issued by the Iranian economists when the budget bill for the Iranian year 1385 (2006-07) was presented to Majlis at the end of 1384 (March 2006). They maintained that excessive growth of liquidity in the budget bill for 2006 had turned in into the most expansionary budget of the whole Iranian history and could have very negative effects on liquidity and inflation.

However, Farhad Rahbar, who was heading Management and Planning Organization at that time, denied any historical relationship between liquidity and inflation in Iran and defended the expansionary budget. The bill was finally approved with little change in figures. In the new study conducted by the International Monetary Fund, excessive increase in governmental expenditures has been mentioned as the most important reason for liquidity growth and the subsequent inflation. The study has emphasized that there is no evidence to show that structural changes have been made in the relationship between liquidity and inflation and, therefore, there is no better strategy for curbing inflation except reining liquidity.

In IMF’s study, average inflation rate of Iran has been estimated at 17 percent, but most researchers maintain that it is lower than the real rate.

IMF researchers have noted that the key to Iran’s success in controlling inflation is adopting coordinated monetary and financial policies with the goal of controlling liquidity. The study has noted that the low figure announced on the real rate of inflation (which is equal to nominal interest rate minus inflation rate) has caused Iran’s monetary policies to become expansionary, thus, increasing the existing inflationary pressures.

The International Monetary Fund has noted that liquidity growth will cause inflation, even in short term, and there is no evidence to show that structural changes have been made in the relationship between liquidity and inflation.

Fars news agency also reported that the International Monetary Fund has issued its report on liquidity and inflation in Iran. It said that Iran has been facing high inflation throughout its history and has estimated average inflation rate of the country at over 17 percent since 1979. In addition, what is announced as inflation rate in Iran is always lower than the real rate.

Most written works on inflation in Iran, have mentioned expansion of liquidity as a result of increased state expenditure as the most important cause of inflation. At the same time, inflation rate in Iran has sometimes taken a downturn since 2002 and this issue, has cast doubts on the existence of a logical relationship between liquidity and inflation.

This study has discussed long term and short term factors determining inflation in Iran.

Major results of the study are as follows:

1. There is long-term relationship among prices and liquidity, capital return rate, real production, and foreign exchange rate while liquidity and money play a great role in determining prices.

2. Liquidity growth will cause inflation to rise even in short term and there is no evidence to show that structural changes have been made in the relationship between liquidity and inflation in Iran.

3. It is improbable that the downturn in inflation rate in Iran could be sustained and, in fact, it is projected that remarkable increase in liquidity during recent months will lead to higher inflation rate in the coming years.

With regard to monetary policies of the Iranian government in terms of realizing specified goals of the Fourth Economic Development Plan as to controlling inflation and liquidity, one can claim that those policies have, by no means, been successful.

Increased oil revenues and proportionate rise in government’s expenditures have been blamed as the main cause for the failure of the said policies. Although new grounds have been broken with regard to controlling inflation during recent months, the main goals of reducing inflation rate to a single-digit figure as well as controlling liquidity have not been achieved.

This research has proven that non-realization of projected goals with regard to controlling liquidity is the most important factor for continuation of a two-digit inflation rate in Iran. Existence of a long-term relationship between prices, liquidity, economic growth, investment return rate, and foreign exchange rate confirms this point. The role of money in regulating prices will be played in the long run. In addition, IMF has studied accurate estimates of Iran’s inflation rate in 1988-2006 to show that no structural changes have been made in the relationship between liquidity and inflation in Iran. Reduced inflation rate in Iran during the said period up to the first quarter of the Iranian year 1385 (2006-07) has been a result of reduced rate of liquidity growth in the preceding three months.

It seems that the true effect of the current increase in liquidity on inflation will appear in the coming months when we will be noticing higher inflation. In conclusion, in view of the aforesaid facts, controlling liquidity growth is still a key to government’s success and control of inflation. The stable relationship between liquidity and inflation indicates that controlling liquidity should be a major goal of the government for the foreseeable future. The issue, however, is what approach has been taken to controlling liquidity.