Is the Problem of Time-Inconsistency present in the Iranian Economy?

The purpose of this paper is to analyze the time-inconsistency problem between inflation and unemployment rate series for Iran. The validity of the Barro-Gordon model’s implications is tested by using state-space form and a Kalman filter based on data for the period of 1972 – 2011. In order to investigate the long-run effects of the time-inconsistency problem, unit root and co-integration tests are applied. First, a Kalman filter is used to test the short-run effects. Then the modified Barro-Gordon model’s constraint is applied to remove the trend of inflation and unemployment rate. The results of this study suggest that both inflation and unemployment series are not stationary and having the unit root, but that first differences of the two series are stationary. The co-integration test results also support the Barro-Gordon model’s implications for the long-run behavior of inflation and NAIRU, the two variables are cointegrated. The results of this study suggest the presence of the problem of time-inconsistency for the Iranian economy in the short-run.