The Impacts of Budget Deficit and Inflationary Tax on the Demand Side of Iran's Economy

The government of Iran has faced with budget deficits during 1979 – 2010, which has been financed mainly through money creation. Theoretically, the impacts of budget deficit and inflationary tax on macroeconomy are very controversial, so that both decrease and increase in consumption, investment, net exports and total expenditure have been supported by empirical researches. Using structural cointegrating vector autoregressive, this paper investigates the impacts of inflationary finance on the demand side of Iran’s economy during mentioned period. Budget deficit is defined as the difference between operating budget deficit (minus net operating balance) and capital balance surplus, or net lending (net acquisition of nonfinancial assets). The results show that both operating budget deficit and net lending have positive impacts on consumption, investment and net imports in the short run. So changes in the demand side have not necessarily same orientation with increase or decrease in budget deficits, but the source of change in budget deficit determines its effects. Reducing budget deficits through positive shock to net lending and a policy of increasing operating budget deficit have similar effects. Furthermore, the results show that the operating budget deficit has no effect on demand components in the long run. The complementarity of inflationary tax and financial repression is confirmed in both short run and long run. In addition, the results indicate that an increase in operating budget deficit and/or net lending induce more inflationary tax and financial repression. Although the budget deficit has no effect on demand side in the long run, but its two outcomes -inflationary tax and financial repression- have opposite effects on the consumption, investment and net imports in both short run and long run.