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How can Iran’s black market exchange rate be managed?

The Iranian currency (rial) depreciated on average 12.2 per cent per annum against the U.S dollar during the period 1960-1998 but, despite continued two-digit rates of inflation, the rial has witnessed only a meagre 1.7 per cent fall in its value in the post 1998 era. This paper examines this perplexing issue by identifying the major long-run determinants of the black market exchange rate. This paper uses the multivariate cointegration test, a threshold regression model and annual time series data (1960-2008) to determine exactly at what exchange rate the effect of relative prices on the exchange rate has been subject to an asymmetry adjustment process. We found that the relative CPIs in Iran and the U.S., total stock of foreign debt and the price of crude oil are the major long-run determinants of the black market exchange rate. However, the impact of relative prices (as measured by the magnitude of its elasticity) has significantly diminished from almost unity in the pre 1998 period to less than one-fourth since 1998. Based on our results, if oil prices continue to plunge, liquidity and inflation are out of control and at the same time Iran accumulates more external debt, the exchange rate will eventually exhibit an unprecedented and explosive depreciation in the coming years. No previous study has examined this issue using a threshold regression model without splitting the entire sample into two sections according to an endogenously determined threshold for the exchange rate.

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Paper provided by School of Economics, University of Wollongong, NSW, Australia in its series Economics Working Papers with number wp09-07.

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Length: 14 pages
Date of creation: 2009
Date of revision:
Handle: RePEc:uow:depec1:wp09-07
Contact details of provider: Postal: School of Economics, University of Wollongong, Northfields Avenue, Wollongong NSW 2522 Australia
Phone: +612 4221-3659
Fax: +612 4221-3725
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  1. Mohsen Bahmani-Oskooee, 2005. "History of the Rial and Foreign Exchange Policy in Iran," Iranian Economic Review, Economics faculty of Tehran university, vol. 10(2), pages 1-20, fall.
  2. Denis Kwiatkowski & Peter C.B. Phillips & Peter Schmidt, 1991. "Testing the Null Hypothesis of Stationarity Against the Alternative of a Unit Root: How Sure Are We That Economic Time Series Have a Unit Root?," Cowles Foundation Discussion Papers 979, Cowles Foundation for Research in Economics, Yale University.
  3. Johansen, Soren, 1995. "Likelihood-Based Inference in Cointegrated Vector Autoregressive Models," OUP Catalogue, Oxford University Press, number 9780198774501.
  4. Enders, Walter & Siklos, Pierre L, 2001. "Cointegration and Threshold Adjustment," Journal of Business & Economic Statistics, American Statistical Association, vol. 19(2), pages 166-76, April.
  5. Farzin, Y. H., 1995. "Foreign exchange reform in Iran: Badly designed, badly managed," World Development, Elsevier, vol. 23(6), pages 987-1001, June.
  6. Johansen, Soren, 1991. "Estimation and Hypothesis Testing of Cointegration Vectors in Gaussian Vector Autoregressive Models," Econometrica, Econometric Society, vol. 59(6), pages 1551-80, November.
  7. Abbas Valadkhani, 2003. "An Empirical Analysis Of The Black Market Exchange Rate In Iran," School of Economics and Finance Discussion Papers and Working Papers Series 144, School of Economics and Finance, Queensland University of Technology.
  8. Bahmani-Oskooee, Mohsen, 1996. "The black market exchange rate and demand for money in Iran," Journal of Macroeconomics, Elsevier, vol. 18(1), pages 171-176.
  9. Mohsen Bahmani-Oskooee, 1996. "The Decline of the Iranian Rial During the Post Revolutionary Period: A Productivity Approach," Working Papers 9615, Economic Research Forum, revised May 1996.
  10. Jalal U. Siddiki, 2000. "Black market exchange rates in India: an empirical analysis," Empirical Economics, Springer, vol. 25(2), pages 297-313.
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