Dynamic effects of trade barriers with speculation on foreign currency: The case of Iran

This paper presents a small open economy, dynamic general equilibrium model with cash-in advance constraint and a currency attack to explain the dynamic effects of changes in trade barriers in the short and long run. The model is calibrated using data on macroeconomic variables in Iran's economy from 1990 to 2013 to identify and analyze the effects of barriers imposed on trade. We analyze the effects of counterfactual fiscal, monetary and exchange rate policies in response to trade barriers and show how the economy would respond in different time horizons. We also evaluate the effects of eliminating each of the factors causing this stagflation. Our findings show that the short-term drop in non-oil production is mostly due to the decline in total productivity and not trade barriers. On the other hand, barriers imposed on the trade of oil and non-oil goods had a considerable impact on the decline in non-oil production in the medium and long run, as well as the fall in total income. Finally, we show that the news of trade barrier imposition has a considerable impact on the impulse to speculate, giving rise to a likely currency crisis and devaluation that have a substantial effect on inflation and real output.