Testing the Demand Oriented Approach to Economic Growth in Iran: An Application of Time-Varying Parameter

Post Keynesian growth model considers the use of production factors as a function of production and introduces demand as the main determinant of economic growth. Accordingly, Thirlwall (1979) presented a model suggesting that demand is restrained by the balance of payments deficit and turns into substantial limitations to achieve higher economic growth rate owing to balance of payments deficit. This model is known as Thirlwall law or “balance of payments constrained growth model”. In this model the maximum rate of economic growth consistent with the balance-of-payments equilibrium is figured out using income elasticity of import and export. Identifying the barriers to achieving the target growth rate has been turned into one of the most controversial economic issues because of the challenges of low economic growth in Iran. Thus this study is going to provide an answer to the question that, based on Thirlwall law, Whether the balance of payments deems obstacles to the target growth rates of development programs for the Iran’s economy or not? To accomplish this, first the long run cointegration relationship of import and export demand functions was approved by autoregressive distributed lag model (ARDL). Then, regarding the importance of the elasticities of above functions on the results of the study and removing the structural instability of the model coefficients, time–varying parameter (TVP) and Kalman – filter were used to estimate the elasticities. Finally the validity of Thirlwall law was not confirmed during 1984-2013 applying Wald Test. Therefore, it can be claimed that aggregate demand has not restricted the economic growth through the balance of payments. Low income elasticity of import, combination of imports, restrictions on imports and dependence of foreign trade on oil revenues are the most important reasons for the results.