Inflation and energy price reform in Iran
The dominant view of the high inflation of the last three years blames it on the subsidy reform. (The latest high profile assertion to this effect came from a piece by Hashem Pesaran and Hadi Salehi Esfahani published by the Fars News Agency, to which Mohammad Ali Farzin, the former head of the subsidy reform program, responded by claming that only 10% of the inflation was due to the subsidy reform). Were it not for the fact that blaming energy prices for the destructive inflation of the last three years casts a long shadow over future policy on energy prices, the mere fact that it is wrong would not prompt me to bore the readers of this blog with yet another post on inflation. But the imagined close relationship between energy prices and the average price level, has made fixing energy prices the policy of choice for fighting inflation. Ask why energy prices should stay constant when all other prices are rising, and everyone would tell you because rising energy prices cause inflation. No sane country in the world considers fighting inflation by keeping the prices of fossil fuel down, especially because of the damage it would do to the environment, people’s health, and equity.
Energy price reform is a change in relative prices, and it does inevitably involve some general inflation, but it does not push prices up year after year after it has stopped going up. This is quite obvious rom the inflation graph below, which depicts monthly inflation rates from January 2009 to January 2014. (If you are unable to see the graph, click here.)
Note: Urban monthly inflation rates
Source: The Central Bank of Iran.
The abrupt rise in energy price shock increased the rate of monthly inflation threefold between mid 2010 and the first quarter of 2011. Inflation started to come down only months after the start of the subsidy reform program — three months later to be precise — until other factors pushed it up again. As I have marked on the graph, the first shock was the tightening of the sanctions, which soon led to the collapse of the rial, which was highly over valued to begin with and could not withstand the loss of some $50 billion in annual oil revenues.
And no, it was not the Rouhani administration that brought inflation down — another myth that blurs the understanding of the recent inflation dynamics in Iran. As the graph shows clearly, inflation started to slow down (as it always does after a relative price shock) five months before Rouhani took office.
It is a dangerous myth that inflation in 2012 and 2013 was the result of energy price increases two-three years earlier because it prevents the country from facing up to its responsibility to use energy efficiently and equitably.