Financial Development and Decline in Iran: A Quantitative Dynamic General Equilibrium Model

Private sector's debt to the banking network to GDP ratio has more than doubled during the mid-1990s to the mid-2000s, after which growth has stopped. In this paper, a quantitative dynamic general equilibrium model is introduced to illustrate this phenomenon and calibrate the model based on the macro data of Iran and micro data that is derived from the central bank's survey on household's access to the financial services. From the perspective of the model, the credit cycle is more closely related to issues that directly affect housing prices and, as a result, affect the amount of housing collateral to receive credits. The model can well explain the developments in the credit market in Iran and a significant part of the developments in the housing market. But the macroeconomic effects are relatively small, as the borrower's and lender's responses are mutually suppressed at the same level. This indicates that the contraction of credit since 2007 alone is not able to explain the recession in recent years.