Document Type : Research Paper

Authors

1 Ph.D. Candidate in Economics, Faculty of Economics and Political Science, Shahid Beheshti University, Tehran, Iran

2 Assistant Professor of Economics, Faculty of Economics and Political Science, Shahid Beheshti University, Tehran, Iran

Abstract

Some monetary policymakers attribute the persistent high inflation in Iran’s economy solely to the lack of central bank independence, arguing that granting the central bank autonomy is necessary to reduce inflation. However, empirical studies reveal that central bank independence faces significant structural challenges due to the endogeneity of money within Iran’s economic system. This article aimed to identify the key components of requirements of central bank independence, with a particular focus on the government structure in Iran’s economy. A comprehensive review of existing literature on central bank independence was conducted. Moreover, a grounded theory approach was used to achieve theoretical saturation concerning central bank independence in Iran. Then, the study relied on the Bayesian model averaging (BMA) and analyzed 21 variables to identify the key factors defining the requirements of central bank independence in Iran. The findings highlighted several key factors, including the deviation of the effective exchange rate from the appropriate exchange rate, the government budget deficit, oil revenues, and the government effectiveness index. Furthermore, the results suggested that increasing central bank independence alone, within the context of variables contributing to endogeneity of money under Iran’s current economic conditions, has a weak and fragile effect. Thus, it is essential to undertake structural reforms targeting these critical variables as a prerequisite to meaningful discussions and efforts toward central bank independence.

Introduction

The theory of time inconsistency proposed by Kydland and Prescott (1977) posits that central bank independence can reduce inflation rates without incurring economic costs while enhancing stability by lowering inflationary expectations. However, several empirical studies (e.g., Bauman et al., 2021) emphasize that the effectiveness of central bank independence depends on the unique structural and institutional characteristics of each country. As a result, central bank independence is not a universal solution and may vary depending on the specific structural conditions of each economy. The relationship between central bank independence and inflation rates can significantly differ when structural and institutional factors deviate from the ideal. Iran’s economy has recently undergone substantial fluctuations in inflation rates. Some monetary policymakers attribute these high inflation levels solely to the lack of central bank independence, asserting that greater independence is necessary to control inflation. However, structural factors unique to Iran’s economy complicate this view. Issues such as an inefficient tax system, reliance on oil revenues, underdeveloped financial markets, exchange rate markets, and the quality of governance indicate that money is largely determined endogenously. These structural challenges undermine the effective implementation of central bank independence as a tool to reduce inflation and promote economic growth. Given these complexities, the present study sought to identify the key components necessary for central bank independence within Iran’s economic system. Focusing on the government structure, the study employed a grounded theory approach and Bayesian model averaging (BMA) to identify the requirements for central bank independence in Iran.

Materials and Methods

This research identified categories related to central bank independence by reviewing the existing literature. It used a grounded theory approach to achieve theoretical saturation. As a result, four key categories were identified: the exchange rate market, the government budgeting system, the quality of governance, and the central bank independence. Specific variables were analyzed within each subcategory to uncover the robust components influencing central bank independence in Iran’s economy. To collect data for the analysis, the study used reliable sources, including databases from the Central Bank of Iran, the Statistical Center of Iran, and the World Bank. The concept of central bank independence was treated as a dependent variable, consistent with the methodology proposed by Giannone et al. (2011) and informed by studies such as Rogoff (2019) and Baumann et al. (2021). These studies define the concept in terms of liquidity under optimal conditions. The variables were tested for their significance and intensity of influence on the dependent variable, allowing for the identification of those that retained their effects even when other variables were included in the model.

Results and Discussion

The results presented in Table 1 are based on coefficient calculations and posterior probabilities from 340,000 regressions. They helped identify four variables as statistically robust and non-fragile even when accounting for the presence of all other variables. These variables included the deviation of the effective exchange rate from the appropriate exchange rate, the government budget deficit, oil revenues, and the government effectiveness index. The result is supported by their posterior probabilities, which exceed the prior probability threshold of 50%, as assumed under the uniform distribution in the Bayesian model selection (BMS) method.
Table 1. The Results of the Sampling Process and BMS Estimation Calculations based on 340 Thousand Regressions




A proportion of regressions with



Cond. Pos. Sign


Post SD


Post Mean


PIP


Symbol


 




0.99


1


0.0987


0.5424


0.9999


DEA


1




0.97


1


0.1489


0.5073


0.9880


BDG


2




0.91


1


0.0395


0.1106


0.9417


GOR


3




0.85


0


0.0554


-0.1040


0.8832


EFG


4




0.61


0.9999


0.0389


0.0236


0.3293


COC


5




0.58


0.0198


1.0681


-0.5712


0.2869


RET


6




0.56


0.8809


1.0553


0.5624


0.2839


REO


7




0.56


0.9234


0.2523


0.1344


0.2786


REG


8




0.28


0.8996


0.0048


0.0011


0.1355


BAC


9




0.25


0.0915


0.0733


-0.0120


0.1247


CUK


10




0.21


0.1443


0.0777


-0.0051


0.1219


MAT


11




0.20


0.2831


0.0411


-0.0008


0.0970


GRI


12




0.18


0.3527


0.0634


-0.0059


0.0899


DUM


13




0.19


0.8690


0.0065


0.0013


0.0890


UR


14




0.17


0.9980


0.0031


0.0007


0.0875


EC


15




0.15


0.2192


0.1140


-0.0074


0.0805


TINF


16




0.14


0.4955


0.0148


-0.0015


0.0787


ECI


17




0.15


0.1539


0.0088


-0.0012


0.0676


RLA


18




0.13


0.1276


0.0179


-0.0021


0.0610


DECM


19




0.12


0.8375


0.0055


0.0006


0.0594


HI


20




0.09


0.9091


0.0034


0.0003


0.0549


UNC


21




* Source: Research results
The weighted average of posterior coefficients further revealed that the variable representing the deviation of the effective exchange rate from the appropriate exchange rate is the most influential in the model, exerting the strongest positive effect in terms of intensity. Following this, the government budget deficit, oil revenues, and the government effectiveness index ranked as the next most significant variables, respectively, based on their influence coefficients.  Yet, the results indicated that in the presence of all variables, central bank independence indices (i.e., GRI, CUK, MAT, and DUM) are fragile and statistically insignificant. This is due to their lower posterior probabilities of inclusion compared to the prior probability, underscoring their limited relevance within the model.

Conclusion

Since central bank independence indices lose significance when the four key components are considered, simply enhancing central bank independence is not a viable long-term solution under the current conditions of Iran’s economy characterized by the endogeneity of money. Therefore, during the transition phase, policymakers must prioritize structural reforms in several key areas: reforming the government budgeting system, improving governance with a focus on efficiency and effectiveness, and developing a competitive foreign exchange market capable of establishing an optimal and efficient exchange rate. Only after addressing these foundational issues should efforts to enhance central bank independence proceed, supported by a robust legal framework and coordinated collaboration with the government.

Keywords

Main Subjects

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