The Effect of External Shocks on Iran’s Oil Economy: A DSGE-BVAR Approach

Given the economy’s high dependence on oil revenues combined with oil influential role in government budget in Iran, we seek to examine the impact of oil revenue shocks on Iran’s economy by means of a DSGE-BVAR model. We are further motivated by the observation that government has been less likely to cut current spending in response to frequent plunges in oil revenues. This, in return, has led to higher macroeconomic instability in times of oil price volatility. We identify technology shocks, oil revenue shocks, foreign exchange rate shocks and money supply shocks as the main sources of business cycle fluctuations. After estimating the model with quarterly data over the period 1990:2-2015:1, the analysis of impulse response functions indicates that production and inflation responses to shocks confirm factual data and the relevant theories. In response to monetary and oil revenue shocks, output rises in the short term; while it falls as result of a surge in the general price level. Foreign exchange rate shock generates a decrease in output but it increases in the long run, due to higher investment. Moreover, positive monetary, foreign exchange rate and oil shocks generate an increase in inflation; while technology shocks induce a decrease in inflation.