Tyranny of numbers

Inflation and energy price reform in Iran

Posted in General, Inequality, Inflation, Sanctions, Subsidy reform by Djavad on February 19, 2014

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.

3 Responses

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  1. S said, on March 23, 2014 at 8:30 am

    This piece totally misrepresents the argument of the Baradaran-Salehi article on Fars News. They don’t argue that the inflation of recent years is the result of inflation caused by the rise in energy prices as a result of the subsidy reform. In fact, in their article, they explicitly acknowledge the widely established notion that the rise in energy prices is not a major contributing factor to long-term inflation. Instead, they argue that by fixing the energy prices to a nominal Rial amount, the subsidy reform forced the government to spend more money as a result of the ensuing inflation, thus exacerbating the inflation caused independently by other factors. I don’t know if that’s true or not, but to say that the rise in energy prices by itself was not the cause of the recent wave of inflation is not a proper response to that.

    • Djavad said, on April 4, 2014 at 6:47 am

      You mean Pesaran and Salehi Esfahani. I put my remark in parenthesis so my post would not be misconstrued as representing their entire argument. Their article makes many excellent points about the need for subsidy reform and the mistakes in the Ahmadinejad program with which I fully agree. However, it was this statement that I took issue with (as did the program’s administrator, Mohammad Ali Farzin, whose reply was also referenced): “the payments of the program were out of line with its revenues, which committed the government to back-breaking cash transfers that led to unprecedented inflation in the last two years.” This remark (especially the last part) creates the impression that the authors are blaming the inflation of the last two years on the deficit of the subsidy reform program. While I agree that the 100 trillion rial deficit of the program (about 1% of the GDP) did contribute to inflation, their statement is an exaggeration of the inflationary impact of the program, given the large role of the sanctions and the rial devaluation in inflation during 2012-2013.

  2. Baddu said, on March 9, 2014 at 2:44 am

    I salute Professor Djavad Salehi Isfahani for daring to stand up to Iranian Energy Smugglers Inc. and their economist apologists, wheather colleague or kin, who have turned economic theorey on its head to suite The Three Musketeers’ in The Cabinet. Noise generated by these interest groups has almost silenced economic theorey. The only other Iranian economics professor daring to openly uphold economic theorey is Dr. Musa GhaniNejad, who after all is an Azeri and not an Isfahani!
    Of course there are others who teach the truth, but only in private.
    To all the DD-resistant economists I say,

    Merci et chapeau bas!

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